Empirical testing of the loss provisions of banks in the GCC region

Abstract

PurposeThe purpose of this study is to examine the factors which affect loss provision for loans and investment in Murabaha, Musharka, and Mudarabah for banks in the Gulf Cooperation Council (GCC) region. The effect of prior period earnings, legal and statutory reserves, size of the bank, level of debt, and loan and investment to deposit ratio on the loss provisions of banks are examined for the period 2000‐2003.Design/methodology/approachTo test the factors that explain the loan loss provision and to test the income smoothing hypothesis, debt to equity hypothesis, and reserve hypothesis, a single stage regression model was developed and tested.FindingsThe results indicate that when return on assets (ROA) before tax and loss provisions for the current year is higher than the prior year ROA and the actual capital reserve is below the legal required reserve, then management is expected to increase loss provisions for the current year. This result is robust for all the years of this study.Originality/valueWhile prior research has examined the issue of the loan loss provision in USA, Japan, and Europe, no research has examined the issue of the loss provisions in the GCC region. This study demonstrates that the income smoothing hypothesis is relevant across different regulatory requirements, economic conditions, and different accounting standards. Managers of banks in the GCC region use the loss provision, among other things, to smooth earnings to achieve certain objectives.