Impact of Basel III on the Discretion and Timeliness of Banks’ Loan Loss Provisions

54 Pages Posted: 8 Feb 2021 Last revised: 11 Mar 2021

See all articles by Pearpilai Jutasompakorn

Pearpilai Jutasompakorn

Singapore Institute of Technology

Chu Yeong Lim

Nanyang Business School, Nanyang Technological University

Tharindra Ranasinghe

American University

Kevin Ow Yong

Singapore Institute of Technology

Date Written: January 7, 2021

Abstract

The Basel III Accord tightens capital adequacy requirements for banks by increasing the minimum Tier 1 regulatory capital threshold from 4 to 6 percent. It also emphasizes the need to improve timeliness of loan loss provisions. Using a sample of European banks, we examine the impact of this regulation on banks’ discretionary loan loss provisioning behavior. Underscoring banks’ increased incentives to report higher capital ratios, we observe a post-Basel III increase in banks’ use of discretionary loan loss provisions (DLLPs) for capital management purposes and a corresponding reduction in the use of these provisions for income smoothing purposes. Moreover, we find that the timeliness of loan loss provisions has improved following Basel III. We also find that the post-Basel III increase in capital management behavior is greater for banks that do not face conflicting incentives when using DLLPs to improve Tier 1 versus total capital ratio. In contrast, the improvement in loan loss provisioning timeliness is greater for banks that are less likely to engage in capital management due to these conflicting incentives. Our findings suggest that Basel III has significantly altered banks’ discretionary loan loss provisioning behavior.

Keywords: Basel III Accord, Discretionary Loan Loss Provisions, Earnings Management, Timeliness of Loan Loss Provisions

JEL Classification: G21, G28, G38, M41, M48

Suggested Citation

Jutasompakorn, Pearpilai and Lim, Chu Yeong and Ranasinghe, Tharindra and Yong, Kevin Ow, Impact of Basel III on the Discretion and Timeliness of Banks’ Loan Loss Provisions (January 7, 2021). Nanyang Business School Research Paper No. 21-03, Available at SSRN: https://ssrn.com/abstract=3761820 or http://dx.doi.org/10.2139/ssrn.3761820

Pearpilai Jutasompakorn

Singapore Institute of Technology ( email )

10 Dover Drive
Singapore, 138683
Singapore

Chu Yeong Lim (Contact Author)

Nanyang Business School, Nanyang Technological University ( email )

Singapore, 639798
Singapore

Tharindra Ranasinghe

American University ( email )

United States

Kevin Ow Yong

Singapore Institute of Technology

10 Dover Drive
Singapore, 138683
Singapore

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