Income smoothing among European systemic and non-systemic banks

Abstract

There is scant research on the financial reporting behaviour of global systemically-important banks (G-SIBs) and non-global systemically-important banks (non-G-SIBs). We examine the link between financial reporting and financial system stability given the understanding that income smoothing is a stability mechanism for banks. We empirically examine whether the way G-SIBs use loan loss provisions (LLPs) to smooth income differ compared to non-G-SIBs and the incentive to do so. We examine 231 European banks and find that income smoothing is pronounced among G-SIBs in the post-crisis period and pronounced among non-G-SIBs in the precrisis period. Also, G-SIBs exhibit greater income smoothing when they: (i) have substantial non-performing loans, (ii) are more profitable and meet/exceed minimum regulatory capital ratios (iii) engage in forwardlooking loan-loss provisioning and during recessionary periods. The implication of our findings is that capital regulation and abnormal economic fluctuations create incentives for systemic banks to use accounting numbers (loan loss provisions) to smooth income, which also align with the financial system stability objective of bank regulators. Our findings are useful to accounting standard setters in their evaluation of the role of reported accounting numbers for financial system stability, given the current regulatory environment in Europe which focuses on systemic banks.

Non-performing loans and financial development: new evidence

“…They show that banking sectors with higher capital adequacy ratios and prudent loan loss provisioning report fewer NPLs. Ozili and Thankom (2018) show that European systemic banks, on average, have fewer NPLs than non-systemic banks because systemic banks have superior credit risk management systems to mitigate NPLs compared to non-systemic banks. They also find a negative relationship between bank provisioning and NPLs for both systemic and non-systemic banks in Europe.…”

“…In the literature, GDP growth is often associated with changes in the size of NPLs because NPLs tend to be lower during economic booms and are higher during recessions (Skarica, 2014;Ozili, 2015;Beck et al, 2015). Also, high unemployment levels are associated with high NPLs because high unemployment can affect borrowers' capacity to repay loans (Klein, 2013;Nkusu, 2011;Ozili and Thankom, 2018). The effect of inflation on NPLs is inconclusive in the literature, with mixed evidence (Klein, 2013;Beck et al, 2015).…”

Earning Management or Tax Avoidance? Company Decision on Accounting and Tax Reporting Cost

“…Another reason to do income smoothing to enhance managerial careers or compensation [27], where this cannot be done if ROA is volatile. Research [31] found that banks made high income smoothing when the banks were more profitable or exceed the minimum regulatory capital ratio because abnormal economic fluctuations create incentives for systemic banks to use accounting numbers to smooth income.…”

The Joint Effect of Borrower Targeted Macroprudential Instruments and Capital Regulations on Procyclicality of Loan-Loss Provisions

“…The relation between LLP and current-period earnings realizations (PROF-ITBTP) is applied to track the discretionary income smoothing by banks (Liu & Ryan, 2006;Fonseca & González, 2008;Bouvatier & Lepetit, 2008;Bushman & Williams, 2012;Ozili & Outa, 2018;Ozili & Thankom, 2018). The higher the positive coefficient on PROFIT the more discretionary income smoothing there build up during economic booms.…”