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

Purpose This 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/approach The 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. Findings The 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 implications The 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/value This 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.

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Loan loss provisions, bank valuations and discretion: A comparative study between conventional and Islamic banks

Journal of Economic Behavior & Organization ◽

10.1016/j.jebo.2013.08.018 ◽

2014 ◽

Vol 103 ◽

pp. S160-S173 ◽

Cited By ~ 42

Author(s):

Marwa Elnahass ◽

Marwan Izzeldin ◽

Omneya Abdelsalam

Keyword(s):

Comparative Study ◽

Islamic Banks ◽

Loan Loss ◽

Loan Loss Provisions ◽

Conventional And Islamic Banks

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Benchmarking and crosschecking international banking economic and regulatory capital

Journal of Financial Regulation and Compliance ◽

10.1108/13581980510621974 ◽

2005 ◽

Vol 13 (1) ◽

pp. 65-79 ◽

Cited By ~ 3

Author(s):

John L. Simpson ◽

John Evans

Keyword(s):

Banking System ◽

Performance Model ◽

Capital Adequacy ◽

Future Research ◽

Informational Efficiency ◽

International Banking ◽

Regulatory Capital ◽

Loan Loss ◽

Banking Systems ◽

Loan Loss Provisions

The purpose of this paper is to provide banking regulators with another tool to crosscheck the appropriateness and consistency of levels of capital adequacy for banks. The process begins by examining banking systems and focuses on market risks and the systemic risks associated with growing global economic integration and associated systemic interdependence. The model provides benchmarks for economic and regulatory capital for international banking systems using country, regional and global stock‐market generated price index returns data. The benchmarks can then be translated to crosschecking capital levels for banks within those systems. For analytical purposes systems are assumed to possess a degree of informational efficiency and credit, liquidity and operational risks are held constant or at least assumed to be covered in loan loss provisions. An empirical study is included that demonstrates how market risk and systemic risk can be accounted for in a benchmark banking system performance model. Full testing of the model is left for future research. The paper merely proposes that such an approach is feasible and useful and it is in no way intended to be a replacement for the current Basel Accord.

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