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Are banks using hidden reserves to beat earnings benchmarks? Evidence from Germany

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  • Bornemann, Sven
  • Kick, Thomas
  • Memmel, Christoph
  • Pfingsten, Andreas

Abstract

Section 340f of the German Commercial Code allows banks to provision against the special risks inherent to the banking business by building hidden reserves. Beyond risk provisioning, these reserves are implicitly accepted as an earnings management device. By analyzing financial statements of German banks for the period 1997–2009, we see these hidden reserves being used to (1) avoid a negative net income, (2) avoid a drop in net income compared to the previous year, (3) avoid a shortfall in net income compared to a peer group, and (4) reduce the variability of banks’ net income over time. Our analysis also shows that if bank managers are unable to reach the targets as set out in (1)–(3), they are more inclined to keep the hidden reserves for use in future periods.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 36 (2012)
Issue (Month): 8 ()
Pages: 2403-2415

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Handle: RePEc:eee:jbfina:v:36:y:2012:i:8:p:2403-2415

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Web page: http://www.elsevier.com/locate/jbf

Related research

Keywords: Earnings management; Income smoothing; Hidden reserves; Prospect theory; Financial institution;

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References

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Citations

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Cited by:
  1. Claudia M. Buch & Esteban Prieto, 2012. "Do Better Capitalized Banks Lend Less? Long-Run Panel Evidence from Germany," IAW Discussion Papers 84, Institut für Angewandte Wirtschaftsforschung (IAW).
  2. Köhler, Matthias, 2013. "Does non-interest income make banks more risky? Retail- versus investment-oriented banks," Discussion Papers 17/2013, Deutsche Bundesbank, Research Centre.
  3. Köhler, Matthias, 2012. "Which banks are more risky? The impact of loan growth and business model on bank risk-taking," Discussion Papers 33/2012, Deutsche Bundesbank, Research Centre.
  4. Memmel, Christoph & Gündüz, Yalin & Raupach, Peter, 2012. "The common drivers of default risk," Discussion Papers 36/2012, Deutsche Bundesbank, Research Centre.
  5. Bornemann, Sven & Pfingsten, Andreas & Kick, Thomas & Schertler, Andrea, 2014. "Earnings baths by bank CEOs during turnovers," Discussion Papers 05/2014, Deutsche Bundesbank, Research Centre.

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