Use Of Loan Loss Provisions Research Articles

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.

Managerial discretions and loan loss provisions in Nigerian banks

Aim: The high level of non-performing exposures and the existing crisis in the Nigerian banking sector is a source of concern. To create a basis for solving the troubles caused by the loan loss crisis, this study investigated the managerial discretionary use of loan loss provisions (LLPs) by Nigerian deposit money banks (DMBs). This is considered in the context of solvency risk and reforms embedded in the adoption of International Financial Reporting Standards (IFRSs).
 Design/research methods: Datasets related to the variables of the study were hand-collected from annual reports of a sample of 16 Nigerian deposit money banks over the period of 2007-2017. The analyses were performed using principal components analysis to derive the managerial discretions index (MDI), Prais-Winsten ordinary least square regression to segregate LLP into reported LLPs (TLLP) and discretionary LLPs (DLLP) and appropriate panel data regression models to test the study’s hypotheses subsequent to series of diagnostic tests.
 Conclusions/findings:The results revealed that managerial discretions negatively influence TLLP and DLLP represented by absolute value of DLLP (ADLLP). This represents an increase in profitability without manipulatingloan loss provisions. However, the reforms embedded in IFRSs revealed the use of LLPs for managerial discretions despite reduction in provisioning level noticeable during IFRS. The situation of Nigerian banks threatened by solvency risk use of LLPs for managerial discretions while attempting to increase profit was exemplified in the increase in ADLLP rather than TLLP. However, improvement was noticeable for risky Nigerian banks during IFRS. The managerial discretionary use of LLPs especially during IFRS was engendered by use of LLPs for capital management and earnings smoothing rather than earnings signalling as further revealed. This shows that adoption of International Financial Reporting Standards reduces reporting quality of Nigerian banks in their loan loss decisions.
 Originality/value of the article: The derivation of MDI from measures of earnings smoothing, capital management and earnings signalling is the study’s contribution to accounting for loan losses literature. The adjustments to LLPs to reduce variability of earnings, meet up with minimum regulatory bank capital adequacy ratio and signal strength to absorb future losses encapsulate earnings smoothing, capital management and earnings signalling respectively.
 Implications of the research:The discretionary use of LLPs found in this study beckons an increased level of surveillance, oversights and reforms on the part of the regulators for compliance level devoid of managerial opportunistic behaviour to be identifiablewith Nigerian banks.
 JEL: D22, G21, G28, L20, M41.

Signalling Behaviour and Bank Provisioning Policies in Nigeria: The Conditional Effect of the IFRS Adoption and Solvency Risk

Purpose of the article: Based on the propositions of the signalling hypothesis and prospect theory, this study examined the extent of attempt by Nigerian deposit money banks (DMBs) to solve the issue of adverse selection via signalling their financial prospects using loan loss provisions (LLPs). The empirical test was subject to the DMBs’ riskiness and changes in the accounting rule given failure of a number DMBs and the adoption of the International Financial Reporting Standards (IFRSs) respectively in Nigeria in the recent past.Methodology: Bank-level unbalanced panel datasets of a sample 16 DMBs, which are related to the variables of the study, were hand-extracted from their annual reports and account between 2007 and 2017. The analysis was conducted using the Prais-Winsten regression correlated with panel corrected standard errors (PCSE-PW) owing to the presence of heteroscedastic and autocorrelated residuals in the study’s regression models.Scientific aim: The study examined the relationship between LLPs and one-year-ahead changes in earnings before taxes and LLPs to establish whether Nigerian DMBs signal their financial strength via LLPs.Findings: The study largely found that Nigerian DMBs, regardless of accounting regime and risk of insolvency, do not use LLPs to signal their financial strength. However, where the evidence of signalling via LLPs was evident the coefficient of earnings signalling was insignificant, where it was significant signalling was achievable via discretionary LLPs (DLLP) rather than actual LLPs (TLLP) suggesting manipulative provisioning in the use of LLPs to signal.Conclusions: The study’s findings included empirical communication alerts to the regulators and Nigerian DMBs on the need for improvement in earnings signalling, as the present scenario may be interpreted as a sign of a non-going concern by analytical stakeholders. Limits of research: The generalisation of the study’s findings may be limited by the focus on one regime (IAS 39) of IFRS loan loss reporting but mitigated by the partial implementation of the second regime (IFRS 9) for the first four years in the country.

Income Smoothing through the Use of Loan Loss Provisions and Adjustment of Loan Supply for Subsequent Period considering the Size of Credit Loss：Commercial Banks and Local Banks and Adoption of Expected Credit Loss Model of IFRS 9

[연구목적]본 연구는 은행 특성이 이익유연화 행태와 신용손실의 규모에 따른 신용공급규모 조정 행태에 차별적 영향을 미치는지를 검증하고, 이러한 차이가 IFRS 9의 적용에 영향을 받는지 검증하는 것을 목적으로 한다. [연구방법]시중은행과 지방은행을 은행 특성 차이로 정의하고 IFRS를 적용한 이후10년의 기간을 연구대상으로 선정하였다. 은행 특성이 이익유연화 행태와 신용공급 행태에 차별적 영향을 미칠 것이라는 가설과 이러한 차이가 IFRS 9의 적용에 영향을 받을 것이라는 가설을 수립하고 회귀분석을 수행하였다. [연구결과]첫째, 시중은행과 지방은행간의 이익유연화 행태에 차이가 발견되었다. 둘째, 신용손실의 규모에 따라 후속기간의 신용공급을 조정하는 신용공급 행태에 시중은행과 지방은행간에 차이가 발견되었다. 시중은행은 신용손실의 규모가 커지는 경우 신용공급을 감소시키고 있음을 의미한다. 셋째, IFRS 9의 기대신용손실모형 적용 이후에 지방은행의 이익유연화가 유의적으로 감소하였으나 시중은행의 이익유연화는 유의적으로 증가한 것이 발견되었다. 넷째, IFRS 9의 적용이 시중은행과 지방은행의 신용공급 행태에 미치는 영향은 발견되지 않았다. [연구의 시사점]본 연구의 발견사항은 은행의 감독기관을 포함한 이해관계자에게 시중은행과 지방은행의 이익유연화 행태, 신용공급규모 조정행태와 IFRS 9의 기대신용손실모형 적용이 미치는 영향에 대한 정보를 제공할 것으로 기대한다.

Loan loss provisions and income smoothing – Do shareholders matter?

In this paper, we aim to analyse the role of shareholders in the creation of discretionary loan loss provisions (LLP) and the use of LLP in income smoothing. Using a sample of over 200 Central European banks, we demonstrate that LLP and income smoothing of foreign-owned banks and state-owned banks differ from those of domestic private banks. Foreign and state banks create higher discretionary LLP than private domestic banks. Foreign banks use these LLP to perform discretionary income smoothing, while state banks, in general, do not smooth income. Higher LLP of foreign banks are observed in banks with low asset quality and high profitability. Foreign banks with low profitability that operate in volatile economic environments do not create higher discretionary LLP than domestic private banks. This implies that their risk is not lower than that of locally owned banks, at least on the credit side. In the aftermath of the financial crisis, both foreign and state banks have become more prudent than domestic private banks, and their discretionary LLP are higher. Overall, we provide evidence that foreign and government ownership affect LLP policy in banks. This complements existing results on the differences in loan cyclicality and default risk between foreign, state and domestic private banks.

Bank Branching Applications and Window Dressing: Evidence on Banks’ Strategic Use of Loan Loss Provisions

After the removal of geographic restrictions on branching in 2006, China’s city commercial banks (CCBs) can apply for permission to branch outside their province. This paper shows that CCBs report higher loan loss provisions before filing an application, thereby increasing the provision coverage ratio of nonperforming loans and making the bank look safer to regulators.Our finding is robust to controlling for possible endogeneity of the branching application decision by employing propensity score matching estimators, and it is confirmed when we consider a quasi-natural experiment of deregulation reversal.

Income smoothing through loan loss provisions in south and Eastern European banks

This study provides empirical evidence on income smoothing from the banking sector in nine South-Eastern Europe (SEE) countries for the period 2005-2014 by applying a number of methodological approaches. First, by using a sample of 321 banks this paper confirms our first hypothesis that banks in the SEE region use loan loss provisions (LLPs) to smooth their incomes. Second, by dividing the loan loss provision into its two components (discretionary and non-discretionary,) the study provides new evidence on the effects of loan loss provisions components on growth in bank lending. The results clearly prove our second hypothesis that the components of LLPs do matter on growth in bank lending. Third, this paper estimates the use of loan loss provisions for capital management by banks. The empirical results do not support the hypothesis of capital management for SEE banks. The novelty of this paper, unlike other works, is the inclusion of SEE countries.

The role of banking supervision in credit risk disclosures and loan loss provisions

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.

Strategic Usefulness of Ignorance: Evidence from Income Smoothing via Retained Interest of Securitized Loans

This paper examines the notion of strategic ignorance in an earnings management context. Managers possess less information about loans subjected to securitization and auditors are aware of this shortcoming. Consistent with managers exploiting their own ignorance strategically and using loan loss provisions (LLP) of retained seller’s interest of securitized loans (SIL) more for earnings management than LLP of other loans, we find the use of LLP for income smoothing to be greater for banks that hold SIL. Moreover, the propensity to smooth income via LLP is increasing in the ratio of SIL to total loans. We also find that SIL is particularly useful for income smoothing in the fourth quarter, when greater auditor scrutiny makes it more difficult to manage earnings via LLP of non-securitized loans.

Strategic usefulness of ignorance: evidence from income smoothing via retained interest of securitized loans

This paper examines the notion of strategic ignorance in an earnings management context. Managers possess less information about loans subjected to securitization and auditors are aware of this shortcoming. Consistent with managers exploiting their own ignorance strategically and using loan loss provisions (LLP) of retained seller’s interest of securitized loans (SIL) more for earnings management than LLP of other loans, we find the use of LLP for income smoothing to be greater for banks that hold SIL. Moreover, the propensity to smooth income via LLP is increasing in the ratio of SIL to total loans. We also find that SIL is particularly useful for income smoothing in the fourth quarter, when greater auditor scrutiny makes it more difficult to manage earnings via LLP of non-securitized loans.

Loan-loss provisions, earnings management, and capital management by Russian banks: the impact of changes in banking regulation and oversight

This paper compares earnings management (EM) and capital management (CM) by Russian banks before and after changes in banking regulation and oversight in Russia. In Russia, in recent years, the Central Bank of the Russian Federation has imposed new regulations on banks. In addition, the Central Bank has strengthened its oversight by revoking the license of a large number of banks. Hence, we compare EM and CM before and after these changes in regulation and oversight. We focus on the use of loan-loss provisions (LLPs) for EM and CM. We have three main results. First, we find that banks use LLPs for EM both before and after these changes in regulation and oversight. However, banks’ use of LLPs for EM is similar pre- and post-changes. Second, for the entire sample period, we find mixed evidence of the relationship between capital and LLPs. However, post-changes, the relationship between capital and LLPs is more negative relative to pre-changes. This result is consistent with stronger oversight by regulators post-changes. Third, the difference in CM post-changes relative to pre-changes is different for government-owned banks than for private banks.

Corporate governance, foreign direct investment, and bank income smoothing in African countries

PurposeThe purpose of this paper is to investigate the role of corporate governance mechanisms and foreign direct investment (FDI) to restrain or stimulate the use of loan loss provisions (LLPs) by managers to smooth earnings in African banks.Design/methodology/approachThis study uses a sample of 112 listed and non-listed banks from 20 African countries, covering the period 2011–2017. Models are estimated using the pooled ordinary least squares regression, as well as Blundell and Bond (1998) system GMM.FindingsThe results suggest that bank managers use LLPs to reduce income volatility and that ownership concentration increases income smoothing. The findings also show that FDI plays a fundamental role to restrain managerial discretion in developing countries, increasing corporate governance practices in the host country.Practical implicationsThese findings are relevant for banking regulators and supervisors in order to determine which corporate governance mechanisms can be used in developing countries to increase the quality of financial reporting. A policy model that promotes FDI boosts financial reporting transparency, contributing to greater financial markets development.Originality/valueThe authors extend the existing literature on the influence of corporate governance mechanisms in limiting managerial discretion by focusing on the role that foreign shareholders may have in disciplining banks financial reporting quality in countries with weak institutional quality.

Earnings management and equity incentives: evidence from the European banking industry

PurposeThis study aims to examine the effect of equity incentives on earnings management that occurs via the use of loan loss provisions by using a sample of 204 bank-year observations over the period 2006-2011.Design/methodology/approachThe authors use the data of 39 European banks to test the main hypothesis. Several valuation models and regressions are used to measure the main proxies for executives’ compensation and the determinant factors of loan loss provisions.FindingsThe empirical results reveal that earnings management that occurs via discretionary loan loss provisions is associated with equity incentives in the banking industry. In particular, European banks’ executives with high equity incentives are found to manage reported earnings upwards by reducing loan loss provisions. The results therefore show that income-increasing earnings management via discretionary loan loss provisions is widely practised by the executives of European banks and that this is partly motivated by executives’ compensation.Practical implicationsThe findings of this paper present important implications for regulators in the European Union, who should take further steps to reform the regulatory environment to monitor and mitigate the earnings management practices that occur via the manipulation of loan loss provisions. Earnings management practices do not just negatively affect subsequent performance but are also found to lead to firms’ failure. Thus, regulators should take the necessary reforms to protect the wealth of stakeholders (investors, creditors, etc.).Originality/valueThis study provides the first evidence on the relationship between equity incentives and earnings management in the European banking industry. The study sheds more light on an issue of great interest to a broad audience that does not receive much attention in the prior research, thus opening new avenues for future research.

Bank income smoothing in South Africa: role of ownership, IFRS and economic fluctuation

PurposeThe purpose of this paper is to examine the determinants of the use of loan loss provisions (LLPs) to smooth income by banks in South Africa. More specifically, the authors examine the influence of ownership, IFRS disclosure rules and economic fluctuation on the income smoothing behaviour of South African banks while controlling for the traditional determinants of bank income smoothing via LLPs.Design/methodology/approachThe study employs fixed effect regression methodology to estimate the determinants of discretionary LLPs.FindingsThe authors find that South African banks do not use LLPs to smooth income when they are: under-capitalised, have large non-performing loans and have a moderate ownership concentration. On the other hand, income smoothing is pronounced when South African banks are rather more profitable during economic boom periods, well-capitalised during boom periods and is pronounced among banks that adopt IFRS and among banks with a Big 4 auditor. The authors also find that banks use LLPs for capital management purposes, and bank provisioning is procyclical with economic fluctuations.Practical implicationsBank supervisors in South Africa should monitor the bank provisioning practices in South Africa closely to ensure that LLPs are not used as a substitute for bank capital. Banks in South Africa should not use sufficient provisioning as a substitute for sufficient bank capital. Second, the evidence for procyclical bank provisioning shows that provisioning by South African banks reinforce the current state of the economy and might compel bank supervisors in South Africa to consider the adoption of a dynamic provisioning system that is already adopted by bank supervisors in Spain, Peru, Uruguay, Colombia and Bolivia.Originality/valueBank income smoothing is an important issue because it has implications for banking stability and accounting transparency. There are few studies on bank income smoothing for emerging economies particularly in Africa where there are substantial differences in ownership and accounting rules. This is the first South African study to examine the influence of disclosure rules, ownership and economic cycle fluctuations on bank income smoothing behaviour via LLPs.

Bank Income Smoothing in South Africa: Role of Ownership, IFRS and Economic Fluctuation

We examine the determinants of the use of loan loss provisions to smooth income by banks in South Africa. More specifically, we examine the influence of ownership, IFRS disclosure rules and economic fluctuation on the income smoothing behaviour of South African banks while controlling for the traditional determinants of bank income smoothing via loan loss provisions. We find that South African banks do not use loan loss provisions to smooth income when they are (i) undercapitalised, (ii) have large non-performing loans and (iii) have a moderate ownership concentration. On the other hand, income smoothing is pronounced when South African banks are rather (iv) more profitable during economic boom periods, (v) well-capitalised during boom periods (iv) and is pronounced among banks that adopt IFRS and among banks with a Big 4 auditor. We also find that banks use loan loss provisions for capital management purposes, and bank provisioning is procyclical with economic fluctuations. Bank supervisors in South Africa should monitor the bank provisioning practices in South Africa closely to ensure that loan loss provisions are not used as a substitute bank capital. Banks in South Africa should not use sufficient provisioning as a substitute for sufficient bank capital. Secondly, the evidence for procyclical bank provisioning shows that provisioning by South African banks reinforce the current state of the economy and might compel bank supervisors in South Africa to consider the adoption of a dynamic provisioning system that is already adopted by bank supervisors in Spain, Peru, Uruguay, Colombia and Bolivia.

Capital and Earnings Management: Evidence from Alternative Banking Business Models

This paper examines whether institutional characteristics distinguishing Islamic from conventional banks lead to distinctive capital and earnings management behavior through the use of loan loss provisions. In our sample countries, the two banking sectors operate under different regulatory frameworks: conventional banks currently apply the “incurred” loan loss model until 2018 whereas Islamic banks mandatorily adopt an “expected” loan loss model. Our results provide significant evidence of capital and earnings management practices via loan loss provisions in conventional banks. This finding is more prominent for large and loss-generating banks. By contrast, Islamic banks tend not to use loan loss provisions in either capital or earnings management, irrespective of the bank's size, earnings profile, or the structure of their loan loss model. This difference may be attributed to the constrained business model of Islamic banking, strict governance, and ethical orientation.

Loan Loss Provisions, Earnings Smoothing and Capital Management Under IFRS: The Case of Deposit Money Banks in Nigeria

The paper examines the impact of IFRS adoption on the use of loan loss provisions (LLPs) to manage earnings and capital by listed deposit money banks in Nigeria. The study employed an ex-post facto research design and a sample of fourteen (14) Deposit Money Banks listed on the Nigerian Stock Exchange. Data was obtained from 2009 to 2014 to capture the pre- and post- IFRS adoption periods. Using paired sample t-test, we find quantitative evidence to the effect that there are significant increase in the means of loan loss provisioning, and capital management by Deposit Money Banks in Nigeria in the post IFRS adoption period compared to the pre-IFRS adoption period. However, the levels of earnings smoothing are significantly lower in the post IFRS period. The implication of this finding is that adoption of IFRS improved earnings quality in the sense of reduced earnings smoothing.

Financial crisis and international supervision: New evidence on the discretionary use of loan loss provisions at Euro Area commercial banks

We examine the discretionary use of loan loss provisions during the recent financial crisis, when Euro Area banks experienced not only a negative effect on the quality of their loans and a reduction in their profitability, but were also subject to a new form of stricter supervision, namely the EBA 2010 and 2011 stress test exercises. Overall, we find support for the only income smoothing hypothesis and we do not observe any difference in listed banks’ behavior when compared to unlisted banks. Banks subject to EBA stress tests had higher incentives to smooth income only for the 2011 EBA exercise, when a larger and more detailed set of information was released. This may suggest an unwilled side effect that accounting setters and banking regulators and supervisors should account for.

Loan Loss Provisions, Income Smoothing and Loan Growth: Evidence from Islamic Banks

This paper analyses income smoothing behavior and procyclical effect of loan loss provisions in Islamic bank. The model includes the use of loan loss provisions for discretionary and non-discretionary purposes in Islamic banks and relates it to the ways of Islamic banks disburse loans. The empirical results show that Islamic banks use loan loss provisions for non-discretionary purposes, while well-capitalized banks and banks focusing on lending activities may use loan loss provisions for income smoothing to a lesser extent. Moreover, it is documented that higher non-discretionary component of loan loss provisions results in a decline in loan growth and hence, non-discretionary provisions are procyclical. In contrast, the discretionary component of loan loss provisions does not exhibit any significant impact on loan growth. Finally, the findings show that the negative link between non-discretionary provisions and loan growth does not hold for well-capitalized banks, and banks focusing on lending activities. This paper, therefore, highlights that higher capitalization and higher loan asset portfolios tend to neutralize the procyclical impact of non-discretionary provisions through their income smoothing behaviour. In this regard, the provisioning system is particularly recommended for less-capitalized banks and banks which do not focus on lending activities since they do not conduct income smoothing strategies.