Discretionary Loan Loss Provisions Research Articles

Bank audit committee financial expertise and timely loan loss recognition

AbstractThis study investigates the effects of audit committee financial expertise on the timeliness of banks' loan loss provisions. I employ two regulatory shocks that mandated audit committee expertise—the Federal Deposit Insurance Corporation Improvement Act in 1991 (FDICIA) and a modified listing standard for NYSE and NASDAQ firms in 1999—as quasi‐exogenous settings to investigate the effects of audit committee financial expertise on the timeliness of loan loss provisioning. Using a difference‐in‐differences research design, I find that the timeliness of loan loss provisions increases with audit committee financial expertise both for the FDICIA treatment group, which had larger banks than the control group, and for the NYSE and NASDAQ exchange treatment group, which had smaller banks than the control group. Further, I find that the results are stronger for banks that have lower regulatory scrutiny, are audited by Big 4 auditors, and do not have staggered boards. Finally, I find that audit committee financial expertise decreases discretionary loan loss provisions and financial restatements. Overall, these findings suggest the importance of audit committee financial expertise in loan‐related matters, which is particularly relevant in the context of the recent Current Expected Credit Losses implementation.

THE IMPACT OF THE FORWARD-LOOKING EXPECTED LOSS METHOD REFERS TO FINANCIAL ACCOUNTING STANDARD NO. 71 ON EARNINGS QUALITY OF THE INDONESIAN ISLAMIC BANKS

The aim of this research is to test and analyze the effect of applying the Expected Loss Method on earnings quality in the context of the pandemic surrounding. The research sample consisted of 16 Islamic commercial banks registered with the Financial Services Authority for the 2019-2022. Using panel regression analysis techniques processed through STATA 18, this research measures earnings quality with discretionary loan loss provisions (DLLP). Control variables include liquidity, which is proxied by the financing-to ratio (FDR), efficiency by BOPO, and bank size by Ln Total Financing. The results show that the impact of EFL on earnings quality is positively significant. This means that the higher the implementation of EFL, the greater the increase in DLLP, which indicates a further decline in earnings quality. During the pandemic, DLLP 27.98 demonstrated a higher value compared to non-pandemic periods, indicating a decline in earning quality during that period. This research provides input for regulators in drafting regulations related to CKPN, which is prone to being used as an earnings management tool. For investors, these findings can help in evaluating bank performance to make better investment decisions.

Board Diversity and Earnings Quality of Listed Deposit Money Banks in Nigeria

Investors’ confidence in the financial reporting process has been hampered because of unethical accounting practices and earnings management and this could be as a result of weak governance structures. The main objective of this study therefore was to examine the effect of board diversity on earnings quality of deposit money banks listed on the floor of the Nigerian Exchange Group from 2014-2023. The independent variable of the study was proxied by board age diversity, board experience diversity and board financial expertise, while the dependent variable was proxied by discretionary loan loss provision. The research design adopted for this study was ex post facto because secondary data were used. The sample size of this study was 10 deposit money banks purposively selected. Ordinary least square regression was used to analyze the data used and statistical software package employed was E-view version 10. The findings of the study revealed that board age diversity has a non-significant negative effect on the discretionary loan loss provisions; experience diversity and board financial expertise have significant negative effect on discretionary loan loss provisions of listed deposit money banks in Nigeria. Thus, it was concluded that board diversity has significant influence on earnings quality of listed deposit money banks in Nigeria. Therefore, it was recommended that the management of deposit money banks should prioritize recruiting board members with robust financial background and expertise to enhance both their earnings quality and financial risk management strategies.

The mediating effect of bank risk on the relationship between diversification strategies and discretionary loan loss provisions

Purpose This study aims to investigate the effect of income and asset diversification on earnings management using discretionary loan loss provisions (LLP) in banks, and the role of risk level in mediating this effect. Design/methodology/approach A sample of banks operating in Middle East and North Africa countries was used to test the mediation model of Baron and Kenny (1986) with different measures of diversification and risk. Findings The results show that bank income and asset diversification have unique and combined effects on earnings management. The results also support the idea that a risk-mediating effect contributes to explaining this relationship among banks. Specifically, bank diversification strategies positively affect LLP-based earnings management by increasing bank risk. This result is relevant for conventional banks. However, only a direct and positive effect of diversification strategies on LLP-based earnings management can be observed in Islamic banks, and the indirect effect is not supported. Originality/value This study extends previous research by examining the unique and combined effects of income and asset diversification strategies on earnings management in the banking sector. Specifically, it provides new evidence that diversification strategies increase LLP-based earnings management, both directly and indirectly, through bank risk.

Bank-Specific Decisions and Banks’ Provisioning Behaviour in Nigeria: The Role of IFRSs Adoption and Banks’ Riskiness

Goal: this study examines the relationship between bank loan loss provisioning behaviour and various bank-specific decisions on loan loss reporting. The evidence is derived from several cases of non-performing exposures of Nigerian deposit money banks. Metodology: to investigate the relationship between bank loan loss provisioning behaviour and various bank-specific decisions on loan loss reporting there was created the loan loss bank-specific decisions index (BDI) according to the International Financial Reporting Standards (IFRSs). The hypotheses are tested by using the estimates of panel corrected standard errors regression model. Findings:the results showed that discretionary adjustments to loan loss provisions (LLPV) are typical of Nigerian banks although the earnings manipulations imbedded in discretionary LLPVs (DLPV) are not factored in. However, during IFRS a reversal is evident suggesting bank-specific decisions prompting increased DLPV except for seemingly financially distressed banks. These findings also confirm the relationship between BDI components and provisioning behaviour in individual tests. The study also found out that the provisioning behaviour in Nigeria during global financial crisis was pro-cyclical (nonrational) while during the local economic recession of 2016–2017, it was counter-cyclical (rational). The latter, which happened during the IFRS period, was characterized by income smoothing while the former was addressed at the level of bank-specific decisions. Originality and contribution of the authors: the study contributes to the literature by testing a list of bank-specific factors engendering adjustments to loan loss decisions. It is unique in terms of the empirical reference to numerous bank-specific decisions as a single factor in accounting for loan losses. The paper also establishes the parochial success of institutional changes in the corporate Nigeria and offers useful suggestions for the way forward.

Expansionary Monetary Policy and Bank Loan Loss Provisioning

We explore how expansionary monetary policy (EMP) influences bank loan loss provisioning. We find that banks’ discretionary loan loss provisions (DLLPs) increase during periods of EMP. This effect is stronger for banks with greater risk-taking, a larger proportion of influential stakeholders, lower ex-ante transparency of loan loss provisions, and more stringent bank regulation, which is consistent with external stakeholders requiring more conservative and timelier loan loss provisioning. We also find that both the timeliness and the validity of banks’ loan loss provisions (LLPs) increase during EMP periods. Our results are robust to the use of instrumental variable estimation and exogenous variations in monetary policy. Lastly, we show that conservative (i.e., higher DLLPs) and timely loan loss provisioning discipline banks from excessive risk-taking during periods of EMP.

The effect of natural disasters on big bath earnings management of banks: evidence from the 2005 US hurricane season

We investigate the effect of the 2005 US hurricane strikes on big bath earnings management in the banking industry. Using a difference-in-differences approach, we find that banks affected by the hurricanes add more discretionary loan loss provisions (DLLP) after the shock relative to unaffected banks. Further tests suggest that the hurricane-induced DLLP increase is attributable to opportunistic big bath accounting rather than to a precautionary motive. We also show that the effect of the hurricanes on big bath earnings management is more pronounced in banks that were managing earnings upwards more aggressively before the hurricanes.

What drives discretionary loan loss provisions? The role of banks' business model, listing status and COVID-19 crisis in the European banking sector

Purpose: This study examines whether banks' business models and listing sta-tus drive the discretionary use of loan loss provisions (LLPs) under the Interna-tional Financial Reporting Standard (IFRS) 9 "Financial Instruments". Design/methodology/approach: Ordinary least squares regression is per-formed on a sample of 5,147 listed and unlisted European banks for the 2018-2021 period. Findings: The main results show that after Expected Credit Loss (ECL) im-plementation, banks are prone to manage their earnings via LLPs. In detail, origi-nate-to-hold and listed banks use LLPs to manage their earnings more strongly than originate-to-distribute and unlisted banks. Further, during the financial crisis due to the COVID-19 pandemic, European banks tended to manage earnings more than during the pre-crisis period. Originality/value: This study contributes to the existing literature by expand-ing research on LLPs and highlighting ex-ante factors that might influence banks' provisioning behavior, such as their listing status and business model. Practical implications: This study provides useful insights for regulators and accounting setters in making informed decisions regarding provisioning policies, even during periods of turmoil.

Bank capital, earnings smoothing and provisioning practices in Nigeria: IFRS and risk evidence

PurposeThis study empirically tests the use of loan loss provisions (LLPs) for earnings and capital smoothing when emphasis is laid on banks' riskiness and adoption of the International Financial Reporting Standards (IFRSs) in Nigeria.Design/methodology/approachAnnual bank-level data are hand-extracted between 2007 and 2017 from annual reports of a sample 16 deposit money banks (DMBs), and analysed using appropriate panel regression models subsequent to a number of diagnostic tests including heteroscedasticity, autocorrelation and cross-sectional dependence. The use of both reported LLPs (TLLP) and discretionary LLPs (DLLP) for earnings and capital management is tested to advance the practice in the literature.FindingsGenerally, the study finds that Nigerian DMBs manage capital via LLPs, while mixed results are obtained for earnings smoothing. However, during IFRS, Nigerian DMBs' management of capital is identifiable with TLLP, while smoothing of earnings is peculiar to DLLP. Additionally, evidence of the improvement in loan loss reporting quality expected during IFRS for riskier Nigerian DMBs, could not be attained. This is corroborated by the study's findings of the use of both TLLP and DLLP for earnings and capital management during IFRS by DMBs in solvency crisis against the only use of TLLP to manage capital found for the entire period.Practical implicationsThe evidential capital and earnings lopsidedness may subject Nigerian DMBs' going-concern to a lot of questions.Originality/valueThe study sets a foremost record in the empirical test of managerial opportunistic behaviour embedded in earnings and capital concurrently while accounting for loan losses by all categories of Nigerian DMBs in terms of riskiness, following accounting regime change.

How do auditor attributes affect bank earnings management? Evidence from Africa

PurposeThis paper aims to examine the impact of the auditor's characteristics on bank's earnings management (EM) through loan loss provisions (LLP) for African banks.Design/methodology/approachThis study is based on 360 bank-year observations from 14 African countries for the period 2011–2016, discretionary LLP is used as proxy for EM. Panel regressions have been conducted.FindingsThe authors' findings reveal that auditor's industry specialization and tenure exert a negative and significant influence on the extent of LLP-based EM. The results also show that total fees paid to the banks' auditors are positively related to the extent of EM. In a further analysis, the authors find that industry specialist auditors are more effective in reducing the incoming-increasing. Similarly, the positive relationship previously found between EM and total fees still holds only for income-increasing. Moreover, auditor tenure negatively impacts both income-increasing and income-decreasing EM. As for auditor change, results reveal differential effect on EM.Originality/valueThe current research extends prior literature and provides an understanding of an important external monitoring mechanism, the external audit, within African banks. To the best of the authors' knowledge, there is a paucity of cross-country studies that has addressed the influence of auditors' attributes on banks' EM in Africa.

Keeping up with the Joneses? Evidence from Peer Performance in the Banking Industry

AbstractThis paper traces the reaction of US banks to ROE underperformance on liquidity creation, equity capital, and loan loss provisions. We find that banks change their structures in the subsequent quarter after underperformance by increasing their on‐balance and off‐balance sheet liquidity creation to increase profitability. Banks tend to increase their equity capital and improve their loan quality by lowering non‐discretionary loan loss provisions to become safer. Banks signal their ability to overcome underperformance by increasing their discretionary loan loss provisions. Our results reveal that large banks rely mainly on off‐balance sheet liquidity creation as their primary tool to recover from underperformance while medium‐size and small banks adjust their equity capital to increase their safety.

AUDIT COMMITTEE AND FINANCIAL REPORTING QUALITY: THE MODERATING EFFECT OF BOARD INDEPENDENCE OF LISTED DEPOSIT MONEY BANKS IN NIGERIA

The widely publicized corporate accounting scandals perpetrated under the watchful eye of audit committee despite their roles and function-ns in financial reporting processes, casts doubt in the minds of users on its relevance and credibility. This study examines the moderating role of board independence on the relationship between audit committee and financial reporting quality of listed Nigerian deposit money banks from 2012 to 2021. The study utilized correlation research design, extracted secondary data and OLS multiple regression for analysis. The finding reveals that board independence has a significant negative moderating effect on audit committee characteristics and financial reporting quality represented by discretionary loan loss provision, thereby strengthen the nexus. Based on the findings, the study recommends the appointment of more outside directors, holding strategic regular meeting and appointment of members with financial expertise into the audit committee to guarantee independence, assure discussion and handling of complex financial issues which would improve the financial reporting quality.

Bank opacity and stability in an emerging market

PurposeThe paper analyzes the impact of bank opacity on financial stability in an emerging economy.Design/methodology/approachBased on a unique dataset of 31 Vietnamese commercial banks from 2007 to 2019, the paper captures earnings opacity via discretionary loan loss provisions and reflects individual bank stability through the accounting-based Z-score index and its disaggregate components. The least squares dummy variable corrected (LSDVC) approach is employed for empirical analysis.FindingsIn contradiction to most studies on developed economies, earnings management improves bank financial stability in Vietnam. Earnings management is more important for the financial stability of smaller banks. Further, the effect of financial information disclosure on bank stability is strengthened by unfavorable macroeconomic conditions, particularly economic downturns, the global financial crisis and uncertain times in banking.Originality/valueThis is the first study to shed light on how bank opacity influences bank financial stability in an emerging market. The evidence with the conditioning roles of bank size and macroeconomic factors, such as uncertainty in banking, is entirely novel in the related literature. Additionally, the paper contributes to a growing body of banking literature by using the LSDVC estimator to examine the association between bank opacity and bank stability.

Cyber attacks, discretionary loan loss provisions, and banks’ earnings management

Cyber threats to banks can indicate high operational risks and a weak internal control system. Our paper is the first to study the impact of banks’ discretionary loan loss provisions on cyber attacks. We investigate whether discretionary loan loss provision of banks can predict a cyber attack and whether banks conduct less or more earnings management following a cyber attack. We find that discretionary loan loss provisions are positively associated with future cyber attacks. We also find that banks will engage in less earnings management following such incidents. We establish the close link between banks’ earnings management and cyber attacks.

Central bank digital currency and bank earnings management using loan loss provisions

PurposeThis paper aims to analyse the role of central bank digital currency (CBDC) in bank earnings management and focus on how CBDC activity might influence banks to engage in accrual earnings management using loan loss provisions (LLPs) and the implications for earnings quality.Design/methodology/approachThe paper used conceptual discourse analysis to explain the role of CBDC in bank earnings management.FindingsBanks will use accruals, such as LLPs, to manage earnings when CBDC-induced bank disintermediation leads to a reduction in bank deposits, a reduction in bank lending and a likely reduction in reported earnings. Bank managers will mitigate the reduction in reported earnings by lowering discretionary LLPs to increase reported earnings.Originality/valueThe recent emergence of CBDC in the digital currency universe has led to increased research interest on the role of CBDC in corporations and society. This study contributes to the literature by focusing on banks, and examining the effect of CBDC on bank earnings management.

Bank provisioning practice during the pandemic: evidence from the COVID-19 outbreak

We investigate whether, and to what extent, banks exploit their discretion over loan loss provisions to achieve their management purposes during the pandemic. Using a sample of US banks during the current COVID-19 outbreak, we find that banks are more eager to use discretionary loan loss provisions in response to the worsening pandemic situation. We find in particular that banks use discretionary loan loss provisions to manage regulatory capital, smooth income and signal private information to outsiders. Overall, this paper enriches the literature on bank discretionary behaviour during the difficult time, especially during the current COVID-19 pandemic, and therefore, it has important implications for banking supervisor and bank stakeholders.

Managerial labor mobility and banks’ financial reporting quality

This paper explores the relationship between managers’ labor mobility and the financial reporting quality of banks. Using the state-level adoption of the Inevitable Disclosure Doctrine (IDD) as an exogenous shock discouraging labor mobility, we show that adoption of the IDD is associated with a decline in financial reporting quality, as measured by discretionary loan loss provisions. The effect is larger for banks with managers who have limited outside job opportunities and smaller for banks with tight regulatory oversight. Our results support the view from the career concern hypothesis that bank managers facing restrictions on mobility have greater incentives to engage in discretionary accounting.

Accounting Discretion, Loan Loss Provision in Financial Distress: Evidence from Commercial Banks

Abstract This study explores the association between earning management practices and financial distress in commercial banks. Earning management is measured through discretionary loan loss provisions and non-discretionary loan loss provisions. Modified Altman’s Z-score has been used as a proxy for financial distress. Panel regression with fixed and random effect has been employed for empirical analysis. The study finds a significant positive association between DLLP, NDLLP and financial distress in terms of the Altman Z-score. In the case of NDLLP, liquidity reduces the probability of financial distress. Whereas, a bank’s SIZE, LEVG and AQ enhance the likelihood of financial distress. The robustness tests were applied to find the association between NDLLP and FD using logistic regression to validate baseline estimates results of the random effect model. The findings of this study have implications for the policymakers, regulators and internal stakeholders to devise effective regulatory measures for well-informed investment decisions.

The effect of earnings management on bank efficiency: Evidence from ECB-supervised banks

This study investigates the impact of earnings management on the efficiency of Eurozone banks, examining its chronological evolution until the implementation of International Financial Reporting Standard 9. Using data on 70 banks, we find that earnings management, defined as discretionary loan loss provisions, negatively affects efficiency. Meanwhile, when we also include non-discretionary provisions (those required by legal obligations), we estimate a positive impact of loan provisions on allocative efficiency—contrarily to a negative effect of discretionary provisions. This finding helps stress the importance of adequately defining earnings management, namely for the purpose of analyzing its effect on banking efficiency.

Uncertainty, bank opacity, and market structure

PurposeThe study examines the impact of uncertainty on bank opacity while particularly taking into account the moderating role of market structures.Design/methodology/approachUsing a sample of Vietnamese banks from 2007 to 2019, the paper measures uncertainty at the disaggregate level of the banking sector through the dispersion of bank shocks and capture bank opacity from the perspective of bank earnings management based on discretionary loan loss provisions. The authors apply both structural and non-structural proxies of bank competition/concentration to better explore the role of market structures. Empirical regressions are conducted using the fixed effect regressions with Driscoll–Kraay standard errors and the two-step system generalized method of moments (GMM) technique, and then verified by the least squares dummy variable corrected (LSDVC) estimator.FindingsBank earnings opacity is less severe in periods of higher uncertainty. Further analysis documents that the negative impact of uncertainty on bank earnings opacity is stronger when the level of bank competition increases or when bank market power decreases.Originality/valueThe finding highlighting the conditioning role of market structures is entirely novel in the uncertainty-bank opacity literature. Moreover, in providing additional evidence on the significant impact of uncertainty on bank opacity, while prior related studies explore economic policy uncertainty, the authors utilize micro uncertainty in banking that exhibits enormous superiority.