Bank Earnings Management Through Loan Loss Provisions: A Double-Edged Sword?

45 Pages Posted: 21 Dec 2013 Last revised: 6 Dec 2014

Lars Norden

Brazilian School of Public and Business Administration (EBAPE), Getulio Vargas Foundation (FGV)

Anamaria Stoian

De Nederlandsche Bank

Date Written: December 5, 2014

Abstract

We investigate the role of loan loss provisions (LLPs) for bank earnings management and risk provisioning. First, banks use LLPs to reduce the volatility of their earnings and banks with less volatile regulatory capital requirements have also less volatile earnings. Second, LLPs are higher when discretionary earnings are high and lower when regulatory capital requirements have decreased. Third, dividend-paying banks manage their earnings upward. Our findings highlight an important trade-off in banks’ provisioning for expected and unexpected losses that influences profitability, risk and payout policies.

Keywords: Bank risk, Earnings management, Bank capital, Discretion, Payout policy

JEL Classification: G21, G28, G34, M41

Suggested Citation

Norden, Lars and Stoian, Anamaria, Bank Earnings Management Through Loan Loss Provisions: A Double-Edged Sword? (December 5, 2014). De Nederlandsche Bank Working Paper No. 404. Available at SSRN: https://ssrn.com/abstract=2369798 or http://dx.doi.org/10.2139/ssrn.2369798

Lars Norden

Brazilian School of Public and Business Administration (EBAPE), Getulio Vargas Foundation (FGV) ( email )

Praia de Botafogo, 190
Rio de Janeiro, 22250-900
Brazil
+552137995759 (Phone)

Anamaria Stoian (Contact Author)

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

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