Paying Bank Risk Professionals to Lie about Bank Loan Loss Provisioning Process

The International Journal of Business and Management. Vol 4, No. 11, 58-63

15 Pages Posted: 3 Dec 2016 Last revised: 2 Mar 2019

See all articles by Peterson K Ozili

Peterson K Ozili

University of Essex - Essex Business School; Central Bank of Nigeria

Date Written: December 1, 2016

Abstract

This paper analyses the effects associated with using the magnitude of realised loan losses as a basis for performance measurement and compensation to credit risk team in banks. Paying and rewarding credit risk professionals on the basis of reporting fewer provisions or lower loan losses motivate credit risk teams to game the system that work to determine loan loss provisions estimate of banks. While bank credit risk teams are sometimes mesmerised by the short-term benefits of provisions games, they do not care if their behaviour destroys bank value and the informativeness of loan loss provisioning estimates. While it is not difficult for bank managers and analysts to understand that the provisioning process is subject to gaming, few of them understand the costs it pose on banks and how to lower this costs. This paper explains how this happens and how provisions games can be stopped or reduced. Using the magnitude of loan losses as a basis to determine the compensation to risk professionals or credit risk teams encourages provisions games. The solution is not to reduce or eliminate provisioning discretion of credit risk teams but rather to de-link credit risk teams’ bonuses from the magnitude of loan loss.

Keywords: Provisions Games; Loan Loss Provisions; Bank Professionals; Credit Risk; Banks; Ethics; Business Ethics

JEL Classification: G21; G28; M14; M52; G32; G35

Suggested Citation

Ozili, Peterson Kitakogelu, Paying Bank Risk Professionals to Lie about Bank Loan Loss Provisioning Process (December 1, 2016). The International Journal of Business and Management. Vol 4, No. 11, 58-63. Available at SSRN: https://ssrn.com/abstract=2878306

Peterson Kitakogelu Ozili (Contact Author)

University of Essex - Essex Business School ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

Central Bank of Nigeria ( email )

Plot 33, Abubakar Tafawa Balewa Way
Central Business District, Cadastral Zone
Abuja
Nigeria

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