Regulatory changes and loan loss provisions management by Chinese banks

Abstract

PurposeThe authors examine whether Chinese banks use loan loss provisions (LLPs) for capital management, income smoothing and signaling purposes, and assess the effect of the recent regulatory changes following the implementation of Chinese Basel III on such behavior.Design/methodology/approachThe authors use a unique set of hand-collected data on bank capital combined with financial data downloaded from the China Stock Market and Accounting Research (CSMAR) database. Multivariate regression models are used to test our hypotheses.FindingsThe authors find that while there is no evidence to suggest capital management practice before the Chinese Basel III, the implementation of the new regulations induced listed banks to manage tier-1 capital via LLPs. The authors also find strong support that Chinese banks engage in income smoothing via LLPs management, and there is no change in such tendency following the issuance of Chinese Basel III. Lastly, the authors do not find support for the signaling behavior by Chinese banks using LLPs.Practical implicationsThe authors’ evidence suggests that elevated tier-1 capital and provisioning requirements may induce capital management by banks, which indicates a potential unintended effect brought forth by the new Basel regulations.Originality/valueTo the best of authors’ knowledge, this study is the first to examine Chinese banks' behavior relating to LLPs in terms of capital management, income smoothing and signaling. In particular, the authors use a sample containing a large number of Chinese commercial banks – previously a major data issue in other studies.