Do Dynamic Provisions Reduce Income Smoothing Using Loan Loss Provisions?
Banco de Espana
University of Zaragoza - Department of Business Administration and Organization
Jesus Saurina Salas
Bank of Spain
September 13, 2011
Banco de Espana Working Paper No. 1118
Spanish banks had to set aside a countercyclical loan loss provision during the period 2000 2004. The amount of such provision as well as the allowance accumulated had to be disclosed by banks. The former creates a natural experiment to test whether banks smooth earnings to mislead investors and other interested parties, or, by contrast, income smoothing is used to avoid the existence of market frictions. Using panel data econometric techniques, we find evidence of income smoothing through loan loss provisions during the period previous to the implementation of the countercyclical provision (1988-1999). However, during 2000-2004, banks relied only on the newly created countercyclical provision to smooth income. This change in behavior suggests that there may be efficiency gains in reducing the volatility of accounting earnings over time.
Number of Pages in PDF File: 30
Keywords: income smoothing, earnings management, transparency, countercyclical provisioning
JEL Classification: G18, G21, M41working papers series
Date posted: September 14, 2011
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