Abstract
In this paper, we analyse the process of income smoothing in Central European banks in the context of expansion strategies of banks. Using a sample of 216 banks in the period 2003–2014, we demonstrate that income smoothing is a strategy most pursued by low-growth financial institutions. This result is particularly visible when the relative expansion rate at local markets is taken into account. High-growth banks are likely to have less foreseeable income streams, loan volumes and loan quality. As income smoothing is a long-term process, the lack of predictability could make forward-making reserve policies more challenging.
Highlights
Income smoothing is a widely spread phenomenon amongst both developed and developing country banks
Income smoothing is performed through adjusting levels of annual loan loss reserves, to the quality of the loan portfolio and to the pre-reserve level of income
Various aspects of the income smoothing process are analysed in the literature
Summary
Income smoothing is a widely spread phenomenon amongst both developed and developing country banks. Income smoothing is performed through adjusting levels of annual loan loss reserves, to the quality of the loan portfolio and to the pre-reserve level of income. In such a case, abundant reserves are made when earnings are high, to allow for diminished reserve burdens in more difficult times [Cavallo, Majnoni, 2002; Perez, Salas-Fumás, Saurina, 2008; Bikker, Metzemakers, 2005; Fonseca, González, 2008]. Bouvatier, Lepetit and Strobel [2014] incorporate regulatory- and corporate governance aspects into income smoothing, while Quaglieriello [2007] and Olszak and Pipień [2014] analyse cyclicality of bank reserves and their link with the business cycle.
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