Does Basel II affect the market valuation of discretionary loan loss provisions?

Abstract

We use a sample of banks from 24 European countries to investigate whether the adoption of the Basel II Capital Accord in 2008 affects the market valuation of discretionary loan loss provisions (DLLPs). Although Basel II lowers the incentives of internal ratingsbased (IRB) banks to recognize income-increasing DLLPs in an opportunistic manner, it has no such impact on the remaining banks, which adopt the Standardized methodology. We use this setup in a difference-in-difference (DiD) design, where Standardized banks act as a control group. Our evidence supports the three hypotheses that, for IRB relative to Standardized banks, Basel II is associated with (i) less income-increasing DLLPs and (ii) less income-smoothing via DLLPs, which enhances the informational content of DLLPs about future loan losses and leads to (iii) higher market valuation of DLLPs. Our findings are timely and have policy implications for future regulatory developments in the banking industry.

Accounting Discretion and the Market Disciplining of Bank Risk-taking Behavior: An Assessment of the Effectiveness of Egyptian Banking Reforms from an Accounting Perspective

“…First, it complements and extends the literature on the role of market discipline in the regulation of banks (Bushman and Williams, 2012;Hamadi, Heinen, Linder, & Porumb, 2016;Ma and Song, 2016;Nier & Baumann, 2006;Rochet, 2005). Market discipline seeks to provide a role for market participants in disciplining bank activities in line with the Basel II Accord.…”

“…More specifically, the study investigates whether accounting discretion is associated with earnings quality and risk-taking in the Egyptian banking sector. Bank discretionary loan loss provisions (LLP) continues to draw the attention of regulators and market participants (Hamadi, Heinen, Linder, & Porumb, 2016;Jin, Kanagaretnam, & Lobo, 2016;Ma & Song, 2016) due to the large magnitude these provisions have on bank financial condition and profitability. Since the early 2000s, the Egyptian banking reforms have been underway to modernize the banking sector and improve its ability to meet the growing financing needs of an emerging economy.…”

Bank loan loss provisions research: A review of the empirical literature

“…First, research related to Basel regulation can be an opportunity for further research. some researchers conducted research related to Basel II regulations (Tschemernjak, 2011;Hudson & Hudson, 2013;Hamadi et al, 2016) Basel III regulations were also the center of attention of several researchers (Lastra, 2014;Schwerter and Schwerter, 2015;Chockalingam, 2018). Based on the directions from the research review (Ozili & Outa, 2017), the research that investigates the impact of loan loss provisions regulation in Basel III and examines whether changes in capital regulation have an impact on the formation of LLP that has been studied (Chockalingam, 2018).…”

Bank Loan Loss Provisions Research: A Review

“…Since Wall and Koch (2000), emerging studies have examined several issues in the loan loss provisioning literature including: provisioning behaviour during fluctuating business cycles and crisis periods (Laeven & Majnoni, 2003;El Sood, 2012;Agenor and Zilberman, 2015), how procylical LLPs contribute to systemic risk and financial system instability (Borio, Furfine, & Lowe, 2001, pp. 1e57;Wong, Fong, & Choi, 2011), dynamic provisioning to mitigate LLP procyclicality (Saurina, 2009;Perez et al, 2011), the role of LLP in bank earnings management, regulatory capital management, signalling and tax management (Lobo & Yang, 2001;Kanagaretnam, Lobo, & Yang, 2005;Anandarajan, Hasan, & McCarthy, 2007;Perez, SalasFumas, & Saurina, 2008;Ozili, 2015Ozili, , 2017aAndries, Gallemore, & Jacob, 2017), bank manager's provisioning discretion under different accounting and regulatory regimes (Alali and Jaggi, 2011;Hamadi, Heinen, Linder, & Porumb, 2016;Kilic, Lobo, Ranasinghe, & Sivaramakrishnan, 2012;Leventis, Dimitropoulos, & Anandarajan, 2011;Marton & Runesson, 2017;Ryan & Keeley, 2013;Wezel, Lau, & Columba, 2012), provisioning and competition (Dou, Ryan, & Zou, 2016), provisioning under different auditor type, reputation and specialism (Dahl, 2013;Kanagaretnam, Lim, & Lobo, 2010;Ozili, 2017a), provisioning discretion under strong corporate governance mechanism and institutional controls (Fonseca and Gonzalez, 2008;Bouvatier, Lepetit, & Strobel, 2014;Curcio & Hasan, 2015) and provisioning behaviour in several country, regional and international contexts (Pain, 2003;…”