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Saving on a Rainy Day? Income Smoothing and Procyclicality of Loan-Loss Provisions in Central European Banks

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  • Dorota Skała

Abstract

type="main" xml:lang="en"> This paper analyses income smoothing and cyclicality of loan-loss provisions (LLP) in Central European banks. I provide strong empirical evidence that banks in the region use loan-loss provisions to smooth their income streams, and that these provisions are procyclical with respect to national business cycles. In addition, I find that income smoothing may only partly be explained through the concept of ‘saving for a rainy day’. Banks do use periods of high earnings to smooth income, but they also elect to build further reserves during periods of heavy losses—that is, on the ‘rainy days’ themselves. This behaviour deepens existing losses and may obscure the bank's underlying profitability. Introducing regulatory measures in line with the Bank of Spain's dynamic provisioning system would make income smoothing in Central European banks more transparent and could limit the scope for discretionary provisioning during periods of low profitability.

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  • Dorota Skała, 2015. "Saving on a Rainy Day? Income Smoothing and Procyclicality of Loan-Loss Provisions in Central European Banks," International Finance, Wiley Blackwell, vol. 18(1), pages 25-46, March.
    • Handle: RePEc:bla:intfin:v:18:y:2015:i:1:p:25-46
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    Cited by:

    1. Ozili, Peterson K, 2017. "Discretionary Provisioning Practices among Western European Banks," MPRA Paper 92645, University Library of Munich, Germany.
    2. Amina Malik & Haroon Aziz & Buerhan Saiti & Shahab Ud Din, 2021. "The Impact of Earnings variability and Regulatory Measures on Income Smoothing: Evidence from Panel Regression," Journal of Central Banking Theory and Practice, Central bank of Montenegro, vol. 10(1), pages 183-201.
    3. Egor Nikulin & Jeff Downing, 2021. "Loan-loss provisions, earnings management, and capital management by Russian banks: the impact of changes in banking regulation and oversight," Eurasian Business Review, Springer;Eurasia Business and Economics Society, vol. 11(4), pages 659-677, December.
    4. Ozili, Peterson K., 2019. "Bank income smoothing, institutions and corruption," Research in International Business and Finance, Elsevier, vol. 49(C), pages 82-99.
    5. Małgorzata Olszak & Sylwia Roszkowska & Iwona Kowalska, 2018. "The Joint Effect Of Borrower Targeted Macroprudential Instruments And Capital Regulations On Procyclicality Of Loan-Loss Provisions," Copernican Journal of Finance & Accounting, Uniwersytet Mikolaja Kopernika, vol. 7(3), pages 29-53.
    6. Ozili, Peterson K, 2017. "Bank Loan Loss Provisions Research: A Review," MPRA Paper 76495, University Library of Munich, Germany.
    7. Ozili, Peterson K, 2019. "Bank Income Smoothing, Institutions and Corruption," MPRA Paper 92339, University Library of Munich, Germany.
    8. García Osma, Beatriz & Mora, Araceli & Porcuna-Enguix, Luis, 2019. "Prudential supervisors’ independence and income smoothing in European banks," Journal of Banking & Finance, Elsevier, vol. 102(C), pages 156-176.
    9. Peterson, Ozili K. & Arun, Thankom G., 2018. "Income smoothing among European systemic and non-systemic banks," The British Accounting Review, Elsevier, vol. 50(5), pages 539-558.
    10. Tito Tomas Siueia & Jianling Wang, 2017. "Loan Loss Provisions, Income Smooth, Signaling, Capital Management and Pro-Cyclicality: Empirical Evidence from Mozambique¡¯s Commercial Banks," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 9(11), pages 48-63, November.
    11. Małgorzata Olszak & Mateusz Pipień & Iwona Kowalska & Sylwia Roszkowska, 2017. "What Drives Heterogeneity of Cyclicality of Loan-Loss Provisions in the EU?," Journal of Financial Services Research, Springer;Western Finance Association, vol. 51(1), pages 55-96, February.
    12. Malgorzata Olszak & Iwona Kowalska & Patrycja Chodnicka-Jaworska & Filip Switala, 2016. "Bank-Specific Determinants Of Sensitivity Of Loan-Loss Provisions To Business Cycle," Faculty of Management Working Paper Series 32016, University of Warsaw, Faculty of Management.
    13. Małgorzata Olszak & Iwona Kowalska & Patrycja Chodnicka-Jaworska & Filip Świtała, 2020. "Do cyclicality of loan-loss provisions and income smoothing matter for the capital crunch – the case of commercial banks in Poland," Bank i Kredyt, Narodowy Bank Polski, vol. 51(4), pages 383-436.
    14. Malgorzata Olszak & Patrycja Chodnicka-Jaworska & Iwona Kowalska & Filip Œwita³a, 2017. "The effect of capital ratio on lending: Do loan-loss provisioning practices matter?," Faculty of Management Working Paper Series 22017, University of Warsaw, Faculty of Management.

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