Abstract

Purpose – The aim of this paper is to analyse the effect of the level of supervisory power on the level of disclosure of loan loss provisions and on the use of this item for income smoothing purposes. Design/methodology/approach – Our sample includes 60 European banks from 15 countries, covering the period between 2012 and 2015. We use an index based on the measure of supervisory power and we estimate three regression models in order to investigate the role of banking supervision in credit risk disclosure and in the use of loan loss provisions for income smoothing purposes. Findings – The results show that banks from countries with a higher level of supervisory power disclose more information about loan loss provisions. However, banks from countries with a higher level of supervisory power only disclose more information regarding Pillar 3 and not IFRS 7. Additionally, we conclude that managerial discretion is lower in banks domiciled in countries with high enforcement. Originality/value – This study is useful for bank supervisors as it raises awareness about their influence on the disclosure of impairment losses on financial assets, and for users of financial statements as insights are provided about the relationship between supervisory power and income smoothing.

Highlights

  • There has been much debate concerning the recognition, measurement, and disclosure of financial assets under international accounting standards and their role in the financial crisis of 2008 (Barth & Landsman, 2010; Laux & Leuz, 2010)

  • Unlike Bischof et al (2016), who focus on several disclosures related to financial instruments, we focus on credit risk disclosures

  • This study examines the role of supervisors in the disclosure of impairment losses on one specific type of financial asset – the loans to and receivables from customers

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Summary

Introduction

There has been much debate concerning the recognition, measurement, and disclosure of financial assets under international accounting standards and their role in the financial crisis of 2008 (Barth & Landsman, 2010; Laux & Leuz, 2010). In regimes with greater intervention by regulators, these studies report that supervisors require higher allowances for incurred losses beyond those allowed by the International Accounting Standard (IAS) 39 – Financial Instruments: Recognition & Measurement to counteract the “too little, too late” issue These supervisors demand that banks provide additional disclosures on impairment losses. This study is useful for bank supervisors as it raises awareness about their influence on financial assets through the disclosure of impairment losses and for users of financial statements as the study provides insights about the relationship between disclosure and earnings management It contributes to the debate about EU-wide inconsistency in the application of IFRS and Pillar 3 disclosure requirements that hinders the comparability of institutions’ level of risk.

Background and context
Literature review and hypotheses development
Sample selection
Role of banking supervision in LLP disclosure
Role of banking supervision in income smoothing
Descriptive statistics
The role of banking supervision in LLP disclosure
The influence of the Single Supervisory Mechanism on income smoothing
The influence of the LLP disclosure on income smoothing
Conclusions
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