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Discretionary Loan Loss Provisions and Systemic Risk in the Banking Industry

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  • Mary L. Z. Ma
  • Victor Song

Abstract

This study examines the relation between earnings management through discretionary loan loss provisions (LLPs) and systemic risk in the U. S. banking sector using a large sample of commercial banks from 1996 to 2009. We find that earnings management increases a bank's contribution to systemic crash risk and systemic distress risk, consistent with the notion that earnings management increases information opacity, facilitates bad news hoarding, co‐moves with macroeconomic conditions, and exhibits cross‐sectional correlation and herding in earnings management. However, the effect of earnings management through discretionary LLPs on systemic risk disappears during the crisis period, consistent with weakened earnings management in crisis times. We also find that the same effect strengthens with bank uncertainty and homogenous loans, and weakens in the post‐SOX period, and when banks are audited by Big 4 auditors. Provisions discrétionnaires pour prêts douteux et risque systémique dans le secteur bancaire Résumé Les auteurs étudient la relation entre la gestion du résultat au moyen de provisions discrétionnaires pour prêts douteux et le risque systémique dans le secteur bancaire aux États‐Unis, au cours de la période 1996–2009, à l'aide d'un vaste échantillon de banques commerciales. Ils constatent que la gestion du résultat accroît la contribution d'une banque au risque systémique d'effondrement et au risque systémique de difficultés financières, conformément à la notion selon laquelle la gestion du résultat accroît l'opacité de l'information, facilite la rétention de l'information négative, varie selon la conjoncture macroéconomique et met en évidence la corrélation transversale et l'effet d'entraînement dans la gestion du résultat, ce qui favorise la contagion informationnelle et le risque systémique. Les effets de la gestion du résultat au moyen de provisions discrétionnaires pour prêts douteux sur le risque systémique se dissipent toutefois en période de crise, ce qui confirme la modération de la gestion du résultat en temps de crise. Les auteurs constatent également que ces mêmes effets s'accentuent avec la croissance de l'incertitude bancaire et de l'homogénéité des prêts et s'atténuent au cours de la période postérieure à l'adoption de la SOX et lorsque l'audit des banques est confié aux Quatre Grands.

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  • Mary L. Z. Ma & Victor Song, 2016. "Discretionary Loan Loss Provisions and Systemic Risk in the Banking Industry," Accounting Perspectives, John Wiley & Sons, vol. 15(2), pages 89-130, June.
    • Handle: RePEc:wly:accper:v:15:y:2016:i:2:p:89-130
    DOI: 10.1111/1911-3838.12091
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