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

Journal title FINANCIAL REPORTING
Author/s Alessandra Allini, Fiorenza Meucci, Flavio Spagnuolo, Annamaria Zampella
Publishing Year 2023 Issue 2023/2
Language English Pages 26 P. 71-96 File size 234 KB
DOI 10.3280/FR2023-002003
DOI is like a bar code for intellectual property: to have more infomation click here

Below, you can see the article first page

If you want to buy this article in PDF format, you can do it, following the instructions to buy download credits

Article preview

FrancoAngeli is member of Publishers International Linking Association, Inc (PILA), a not-for-profit association which run the CrossRef service enabling links to and from online scholarly content.

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.

Keywords: loan loss provisions, business model, listing status, earnings manage-ment.

Jel codes: M40, M41

  1. Ahmed A. S., Takeda C. and Thomas S. (1999). Bank loan loss provisions: A re-examination of capital management, earnings management and signaling effects. Journal of accounting and economics, 28(1), pp. 1-25.
  2. Anandarajan A., Hasan I. and McCarthy C. (2007). Use of loan loss provisions for capital, earnings management and signalling by Australian banks. Accounting & Finance, 47(3), pp. 357-379,
  3. Andreou P. C., Karasamani I., Louca C. and Ehrlich D. (2017). The impact of managerial ability on crisis-period corporate investment. Journal of Business Research, 79, pp. 107-122,
  4. Andries K., Gallemore J. and Jacob M. (2017). The effect of corporate taxation on bank transparency: Evidence from loan loss provisions. Journal of Accounting and Economics, 63(2-3), pp. 307-328,
  5. Anginer D., Bertay A. C., Cull R., Demirgüç-Kunt A. and Mare D. S. (2019). Bank regulation and supervision ten years after the global financial crisis. World Bank Policy Research Working Paper, (9044).
  6. Araujo D., Cohen B. and Pogliani P. (2021). Bank loan loss provisioning during the Covid crisis. BIS Quarterly Review, March. -- Available here: https://www.bis.org/publ/qtrpdf/r_qt2103w.htm.
  7. Azzali S., Fornaciari L. and Mazza T. (2014). Earnings management in bank industry. Economia Aziendale Online, 5(2), pp. 99-110,
  8. Azzali S., Fornaciari L. and Mazza T. (2016). Income smoothing via loan loss provision in credit cooperative banks. Financial Reporting, 2, pp. 33-54, DOI: 10.3280/FR2016-002002
  9. Basel Committee on Banking Supervision [BCBS] (2021). The procyclicality of loan loss provisions: a literature review. -- Available at https://www.bis.org/bcbs/publ/wp39.pdf.
  10. Beatty A.L., Ke B. and Petroni K.R. (2002). Earnings management to avoid earnings declines across publicly and privately held banks. The Accounting Review, 77(3), pp. 547-570,
  11. Beatty A. and Liao S. (2011). Do delays in expected loss recognition affect banks’ willingness to lend?. Journal of Accounting and Economics, 52(1), pp. 1-20,
  12. Bord V. and Santos J.A. (2012). The rise of the originate-to-distribute model and the role of banks in financial intermediation. Economic Policy Review, 18(2), pp. 21-34.
  13. Bouvatier V. and Lepetit L. (2012). Provisioning rules and bank lending: A theoretical model. Journal of Financial Stability, 8(1), pp. 25-31,
  14. Onado M., Bruno B. and Lusignani G. (2018). A securitisation scheme for resolving Europe’s problem loans. In Finance and investment: the European case (pp. 157-167). Oxford University Press.
  15. Bushman R. and Williams C. (2012). Accounting discretion, loan-loss provisioning, and discipline of banks’ risk taking. Journal of Accounting and Economics 54, pp. 1-18,
  16. Caporale G.M., Alessi M., Di Colli S. and Lopez J.S. (2018). Loan loss provisions and macroeconomic shocks: Some empirical evidence for Italian banks during the crisis. Finance Research Letters, 25, pp. 239-243,
  17. Ceccobelli G. and Giosi A. (2019). Earnings management practices in the banking industry: The role of bank regulation and supervision. Corporate Governance: Search for the Advanced Practices, pp. 193-214.
  18. Curcio D., De Simone A. and Gallo A. (2017). Financial crisis and international supervision: New evidence on the discretionary use of loan loss provisions at Euro Area commercial banks. The British Accounting Review, 49(2), pp. 181-193,
  19. Danisman G.O., Demir E. and Ozili P. (2021). Loan loss provisioning of US banks: Economic policy uncertainty and discretionary behavior. International Review of Economics & Finance, 71, pp. 923-935,
  20. Dechow P.M., Myers L.A. and Shakespeare C. (2010). Fair value accounting and gains from asset securitizations: A convenient earnings management tool with compensation side-benefits. Journal of Accounting and Economics, 49(1-2), pp. 2-25,
  21. Dong M. and Oberson R. (2021). Moving toward the expected credit loss model under IFRS 9: capital transitional arrangement and bank systematic risk. Accounting and Business Research, pp. 1-39, DOI: 10.1080/00014788.2022.2063104
  22. Di Martino G., Dicuonzo G., Galeone G. and Dell’Atti V. (2020). Le loan loss provisions nel processo di armonizzazione europea della regolamentazione bancaria. RIREA, 2, pp. 233-256.
  23. Du N., Allini A. and Maffei M. (2022). How do bank managers forecast the future in the shadow of the past? An examination of expected credit losses under IFRS 9. Accounting and Business Research, pp. 1-24, DOI: 10.1080/00014788.2022.2063104
  24. El Sood H.A. (2012). Loan loss provisioning and income smoothing in US banks pre and post the financial crisis. International Review of Financial Analysis, 25, pp. 64-72,
  25. Financial Stability Forum (2009). Financial stability forum re‐established as the financial stability board. -- Available at https://www.fsb.org/wp-content/uploads/R020409.pdf.
  26. Fonseca A.R. and González F. (2008). Cross-country determinants of bank income smoothing by managing loan-loss provisions. Journal of Banking & Finance, 32(2), pp. 217-228,
  27. Gaffney E. and McCann F. (2018). Credit risk under IFRS 9 accounting reforms: An application to Irish mortgages. Central Bank of Ireland Research Technical Paper.
  28. Gaston E. and Song M.I. (2014). Supervisory roles in loan loss provisioning in countries implementing IFRS. International Monetary Fund.
  29. Giner B. and Mora A. (2019). Bank loan loss accounting and its contracting effects: The new expected loss models. Accounting and Business Research, 49(6), pp. 726-752, DOI: 10.1080/00014788.2019.1609898
  30. Gippel J., Smith T. and Zhu Y. (2015). Endogeneity in accounting and finance research: Natural experiments as a state‐of‐the‐art solution. Abacus, 51(2), pp. 143-168.
  31. Giunta F. (2014). Detecting Earning Manipulations: time think about European SMEs. A call for a joint international research project. Financial Reporting, 2-3, pp. 5-15, DOI: 10.3280/FR2014-002001
  32. Gomaa M., Kanagaretnam K., Mestelman S. and Shehata M. (2019). Testing the efficacy of replacing the incurred credit loss model with the expected credit loss model. European Accounting Review, 28(2), pp. 309-334, DOI: 10.1080/09638180.2018.1449660
  33. Hasan I. and Wall L.D. (2004). Determinants of the loan loss allowance: Some cross‐country comparisons. Financial Review, 39(1), pp. 129-152,
  34. Hashim N., Li W. and O’Hanlon J. (2019). Reflections on the development of the FASB’s and IASB’s expected-loss methods of accounting for credit losses. Accounting and Business Research, 49(6), pp. 682-725, DOI: 10.1080/00014788.2018.1526665
  35. Hong Y., Huseynov F., Sardarli S. and Zhang W. (2020). Bank earnings management and analyst coverage: Evidence from loan loss provisions. Review of Quantitative Finance and Accounting, 55(1), pp. 29-54,
  36. IASB (2014). Basis for conclusions on IFRS 9 financial instruments. IFRS Foundation, July.
  37. Jaggi B., Allini A., Macchioni R. and Zagaria C. (2018). The factors motivating voluntary disclosure of carbon information: Evidence based on Italian listed companies. Organization & Environment, 31(2), pp. 178-202, DOI: 10.1177/1086026617705282
  38. Jin J.Y., Kanagaretnam K., Liu Y. and Lobo G.J. (2019). Economic policy uncertainty and bank earnings opacity. Journal of Accounting and Public Policy, 38(3), pp. 199-218,
  39. Kanagaretnam K., Lobo G.J. and Yang D.H. (2005). Determinants of signalling by banks through loan loss provisions. Journal of Business Research, 58(3), pp. 312-320,
  40. Khan M.S., Scheule H. and Wu E. (2017). Funding liquidity and bank risk taking. Journal of Banking & Finance, 82, pp. 203-216.
  41. Kim J., Kim M. and Lee J.H. (2019). The effect of TARP on loan loss provisions and bank transparency, Journal of Banking & Finance, 102, pp. 79-99,
  42. Krüger S., Rösch D. and Scheule H. (2018). The impact of loan loss provisioning on bank capital requirements. Journal of Financial Stability, 36, pp. 114-129,
  43. Laeven L. and Majnoni G. (2003). Loan loss provisioning and economic slowdowns: too much, too late?. Journal of Financial Intermediation, 12(2), pp. 178-197, DOI: 10.1016/S1042-9573(03)00016-0
  44. Leventis S., Dimitropoulos P.E. and Anandarajan A. (2011). Loan loss provisions, earnings management and capital management under IFRS: The case of EU commercial banks, Journal of Financial Services Research, 40(1), pp. 103-122,
  45. López‐Espinosa G., Ormazabal G. and Sakasai Y. (2021). Switching from incurred to expected loan loss provisioning: Early evidence. Journal of Accounting Research, 59(3), pp. 757-804, DOI: 10.1111/1475-679X.12354
  46. Liu C.C. and Ryan S.G. (2006). Income smoothing over the business cycle: Changes in banks’ coordinated management of provisions for loan losses and loan charge‐offs from the pre‐1990 bust to the 1990s boom. The Accounting Review, 81(2), pp. 421-441,
  47. Liu G. and Sun J. (2022). The impact of COVID-19 pandemic on earnings management and the value relevance of earnings: US evidence. Managerial Auditing Journal, DOI: 10.1108/MAJ-05-2021-3149
  48. Macchioni R., Prisco M. and Allini A. (2021). Expected credit losses and managerial discretion: current practices and future challenge, Management Control, 3, pp. 111-134, DOI: 10.3280/MACO2021-003006
  49. Mechelli A., Cimini R. and Sforza V. (2020). Is IFRS 9 better than IAS 39 for investors’ decisions? Evidence from the European context at the beginning of the transition year. Financial Reporting, 1, pp. 125-148, DOI: 10.3280/FR2020-001004
  50. Morris R.D., Kang H. and Jie J. (2016). The determinants and value relevance of banks’ discretionary loan loss provisions during the financial crisis. Journal of Contemporary Accounting & Economics, 12(2), pp. 176-190,
  51. Ng J., Saffar W. and Zhang J.J. (2020). Policy uncertainty and loan loss provisions in the banking industry. Review of Accounting Studies, 25(2), pp. 726-777,
  52. Nichols D.C., Wahlen J.M. and Wieland M.M. (2009). Publicly traded versus privately held: implications for conditional conservatism in bank accounting. Review of Accounting Studies, 14(1), pp. 88-122,
  53. Novak A. (2014). Business model literature overview. Financial Reporting, 1, pp. 79-130, DOI: 10.3280/FR2014-001004
  54. Novotny-Farkas Z. (2015). The significance of IFRS 9 for financial stability and supervisory rules. Brussels, Belgium: European Parliament.
  55. Novotny-Farkas Z. (2016). The interaction of the IFRS 9 expected loss approach with supervisory rules and implications for financial stability. Accounting in Europe, 13(2), pp. 197-227, DOI: 10.1080/17449480.2016.1210180
  56. Oberson R. (2021). The credit-risk relevance of loan impairments under IFRS 9 for CDS pricing: Early evidence. European Accounting Review, 30(5), pp. 959-987, DOI: 10.1080/09638180.2021.1956985
  57. Olszak M., Pipień M., Kowalska I. and Roszkowska S. (2017). What drives heterogeneity of cyclicality of loan-loss provisions in the EU?. Journal of Financial Services Research, 51(1), pp. 55-96,
  58. Osma B.G., Mora A. and Porcuna-Enguix L. (2019). Prudential supervisors’ independence and income smoothing in European banks. Journal of Banking & Finance, 102, pp. 156-176,
  59. Ozili P.K. (2017). Earnings management in interconnected networks: a perspective. Journal of Economic and Administrative Sciences, 33(2), pp. 150-163, DOI: 10.1108/JEAS-02-2017-0003
  60. Peterson O.K. and Arun T.G. (2018). Income smoothing among European systemic and non-systemic banks. The British Accounting Review, 50(5), pp. 539-558,
  61. Pinto I. and Picoto W.N. (2018). Earnings and capital management in European banks – Combining a multivariate regression with a qualitative comparative analysis. Journal of Business Research, 89, pp. 258-264,
  62. Purnanandam A. (2011). Originate-to-distribute model and the subprime mortgage crisis. Review of Financial Studies, 24(6), pp. 1881-1915.
  63. Taylor D. and Aubert F. (2022). IFRS-9 adoption and income smoothing nexus: A comparison of the post-adoption effects between European and Sub-Saharan African Banks. Journal of Accounting and Taxation, 14(3), pp. 189-202, DOI: 10.5897/JAT2022.0539
  64. Tran D.V., Hassan M.K. and Houston R. (2020). Discretionary loan loss provision behavior in the US banking industry. Review of Quantitative Finance and Accounting, pp. 1-41,
  65. Tinoco M.H. and Wilson N. (2013). Financial distress and bankruptcy prediction among listed companies using accounting, market and macroeconomic variables. International Review of Financial Analysis, 30, pp. 394-419.
  66. Vishnani S., Agarwal S., Agarwalla R. and Gupta S. (2019). Earnings management, capital management and signalling behaviour of Indian banks. Asia-Pacific Financial Markets, 26(3), pp. 285-295,
  67. Zhao Q. (2019). Interaction between securitization gains and abnormal loan loss provisions: Credit risk retention and fair value accounting. Journal of Business Finance & Accounting, 46(7-8), pp. 813-842,

Alessandra Allini, Fiorenza Meucci, Flavio Spagnuolo, Annamaria Zampella, What drives discretionary loan loss provisions? The role of banks’ business model, listing status and COVID-19 crisis in the European banking sector in "FINANCIAL REPORTING" 2/2023, pp 71-96, DOI: 10.3280/FR2023-002003