Only Blunt Tools Left? How IFRS 9 Affects the Earnings and Capital Management of European Banks

Abstract

Previous research establishes the discretionary nature of Loan Loss Provisions as a prominent tool for Earnings and Capital Management in banks. However, the transition from the Incurred Credit Loss model of IAS 39 to the Expected Credit Loss model of IFRS 9 has marginalized this leeway. We investigate the implications of this shift in accounting on the Earnings and Capital Management in European banks by drawing inference from the bank stress test data. Doing so generates two distinct advantages for our identification strategy: first, we have homogeneous incentives, as all banks want to apply Earnings and Capital Management in order to appear resilient in the stress test. Second, it allows us to obtain unpublished data for IFRS 9, such that we can create a panel spanning the old and the new accounting standard. The conjunction of these two attributes makes this setting predestine for investigating the true impact of the novel accounting standard. We find that the analyzed banks employ both Earnings and Capital Management. The level of impairments grows under IFRS 9, in line with the hypothesis of a more objective loan loss provisioning process. Moreover, we show that risk-sensitive capital requirements are proactively managed, whereas the opposite is true for risk-insensitive metrics. Our results are robust to different models, parametrizations, and definitions of required capital.

Keywords: Capital Management, Earnings Management, IFRS 9, Objectivity

JEL Classification: G21, G28, M41