Earnings and Capital Management in Alternative Loan Loss Provision Regulatory Regimes
33 Pages Posted: 27 Jul 2006
Date Written: June 26, 2006
The paper sets an accounting and behavioral framework from which we derive a reduced form equation to test income smoothing and capital management practices through loan loss provisions (PLL) by Spanish banks. Spain offers a unique environment to perform those tests because there are very detailed rules to set aside loan loss provisions and they are not counted as regulatory capital. Using panel data econometric techniques, we find evidence of income smoothing through PLL but not of capital management. The paper draws some lessons for accounting rule setters and banking regulators regarding the current changes in the accounting framework (introduction of IFRS/IAS in Europe) as well as the new capital framework (Basel II). In particular, a very detailed set of rules to set aside loan loss provisions does not prevent managers from decreasing earnings volatility, similarly to what happens in a more principles oriented accounting framework.
Keywords: income smoothing, capital management, IFRS/IAS, Basel II
JEL Classification: G18, G21
Suggested Citation: Suggested Citation