Regulatory Capital and Earnings Management in Banks: The Case of Loan Sales and Securitizations

FDIC Center for Financial Research Working Paper No. 2005-05

41 Pages Posted: 16 May 2005

See all articles by Emre Karaoglu

Emre Karaoglu

Columbia University - Columbia Business School

Date Written: May 2005

Abstract

In this paper, I investigate whether banks use loan sales and securitizations (loan transfers) to manage regulatory capital and earnings. My analysis suggests that banks use gains from loan transfers to influence both reported earnings and regulatory capital after controlling for other economic motivations. The gains can be attributed both to cherry-picking of loans whose market values exceed their book values and also to overvaluation of the retained interests that are carried at fair market value in the case of securitizations. In addition, the use of securitizations for financial statement management is positively associated with the degree of financial reporting discretion available to managers. Finally, regulatory capital considerations seem to play a significant role in the decision to transfer loans, while earnings management considerations are more important in the calculation of reported gains conditional on performing a transfer, particularly in the case of securitizations.

Keywords: Securitization, loan sales, accounting, capital standards, risk measurement

JEL Classification: G18, G14, G21, M41, M43

Suggested Citation

Karaoglu, Nuri, Regulatory Capital and Earnings Management in Banks: The Case of Loan Sales and Securitizations (May 2005). FDIC Center for Financial Research Working Paper No. 2005-05, Available at SSRN: https://ssrn.com/abstract=722982 or http://dx.doi.org/10.2139/ssrn.722982

Nuri Karaoglu (Contact Author)

Columbia University - Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

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