What drives bank income smoothing? Evidence from Africa

Abstract

We investigate whether banks use loan loss provisions to smooth income and whether this behaviour is influenced by foreign bank presence, ownership and institutional quality differences across African countries. We examine 370 banks from 21 African countries from 2002 to 2021. We find evidence that African banks use LLPs to smooth their income when they are more profitable during economic boom or recession. Income smoothing is persistent (i) among banks with a widely dispersed ownership, (ii) among banks with strong government ownership and (iii) among banks with weak government ownership. Income smoothing is also persistent in African countries that have greater corruption control, better regulatory quality and political stability. In contrast, moderate concentrated ownership reduces bank income smoothing. Bank income smoothing is reduced in African countries that have strong rule of law, high government effectiveness, strong foreign bank presence and strong voice and accountability institutions. The implication is that effective corporate governance and institutional quality can constrain the extent of income smoothing by African banks.

Bank Loan Loss Provision Determinants in Non-Crisis Years: Evidence from African, European, and Asian Countries

“…Overall, previous studies show that organizational culture (Luu et al 2023), economic growth target (Ren et al 2023), ownership structure (Ozili and Arun 2023), economic policy uncertainty (Ng et al 2020), the global financial crisis ), government's fiscal support (Degryse and Huylebroek 2023), trade openness (Biswas et al 2024), loan charge-off (Basu et al 2020), auditor characteristics (Mnif and Slimi 2023), and accounting regulation (Kilic et al 2013) are determinants of bank loan loss provision. But previous studies have not considered non-interest income, bank overhead costs, and institutional quality to be determinants of bank loan loss provision, and there is very little understanding of how these non-traditional determinants might affect loan loss provision, particularly in noncrisis years.…”

“…Zimmerman 1990, 1986). The implication of the positive accounting theory for bank loan loss provision is that bank managers also have incentives to alter accounting numbers such as loan loss provision estimates if they have explicit contracts that are tied to loss avoidance, generating higher profits for shareholders or the possibility of receiving higher bonuses for good performance (Beattie et al 1994;Ozili and Arun 2023). When this is the case, bank managers will have incentives to keep fewer loan loss provisions.…”

“…They found that banks in prefecture-level cities that have higher economic growth targets keep more LLPs in order to deal with potential loan losses. Ozili and Arun (2023) considered foreign bank presence, bank ownership, and institutional quality to be determinants of bank income smoothing in African countries. Ozili and Arun (2023) examined whether 370 African banks use loan loss provision to smooth income and whether this behavior is influenced by foreign bank presence, ownership, and institutional quality differences across African countries.…”

“…Ozili and Arun (2023) considered foreign bank presence, bank ownership, and institutional quality to be determinants of bank income smoothing in African countries. Ozili and Arun (2023) examined whether 370 African banks use loan loss provision to smooth income and whether this behavior is influenced by foreign bank presence, ownership, and institutional quality differences across African countries. The authors found that African banks use LLPs to smooth their income, and income smoothing is persistent (i) among banks that have a widely dispersed ownership, (ii) among banks that have strong government ownership, and (iii) among banks that have weak government ownership.…”

“…Four models were used in this study. The models are a variation of the model used in Luu et al (2023), Ren et al (2023) and Ozili and Arun (2023). The first model, Equation (1), estimates the determinants of bank loan loss provision in the full sample.…”