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Do dynamic provisions reduce income smoothing using loan Loss provisions?

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  • Daniel Pérez

    ()
    (Banco de España)

  • Vicente Salas-Fumás

    ()
    (Universidad de Zaragoza and Banco de España)

  • Jesús Saurina

    ()
    (Banco de España)

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    Abstract

    Spanish banks had to set aside a countercyclical loan loss provision during the period 2000 2004. The amount of such provision as well as the allowance accumulated had to be disclosed by banks. The former creates a natural experiment to test whether banks smooth earnings to mislead investors and other interested parties, or, by contrast, income smoothing is used to avoid the existence of market frictions. Using panel data econometric techniques, we find evidence of income smoothing through loan loss provisions during the period previous to the implementation of the countercyclical provision (1988-1999). However, during 2000-2004, banks relied only on the newly created countercyclical provision to smooth income. This change in behaviour suggests that there may be efficiency gains in reducing the volatility of accounting earnings over time.

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    File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/11/Fich/dt1118e.pdf
    File Function: First version, September 2011
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    Bibliographic Info

    Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 1118.

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    Length: 32 pages
    Date of creation: Sep 2011
    Date of revision:
    Handle: RePEc:bde:wpaper:1118

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    Related research

    Keywords: income smoothing; earnings management; transparency; countercyclical provisioning;

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    1. Fudenberg, Drew & Tirole, Jean, 1994. "A Theory of Income and Dividend Smoothing Based on Incumbency Rents," IDEI Working Papers 34, Institut d'Économie Industrielle (IDEI), Toulouse.
    2. Manove, Michael & Padilla, Atilano Jorge, 1998. "Banking (Conservatively) With Optimists," CEPR Discussion Papers 1918, C.E.P.R. Discussion Papers.
    3. Plantin, Guillaume & Sapra, Haresh & Shin, Hyun-Song, 2005. "Marking to Market, Liquidity, and Financial Stability," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 23(S1), pages 133-155, October.
    4. Thakor, Anjan Managing Editor, 2004. "Special issue on bank capital adequacy regulation under the new Basel Accord," Journal of Financial Intermediation, Elsevier, vol. 13(2), pages 89-89, April.
    5. Benston, George J. & Wall, Larry D., 2005. "How should banks account for loan losses," Journal of Accounting and Public Policy, Elsevier, vol. 24(2), pages 81-100.
    6. Bergstresser, Daniel & Philippon, Thomas, 2006. "CEO incentives and earnings management," Journal of Financial Economics, Elsevier, vol. 80(3), pages 511-529, June.
    7. Anand Mohan Goel & Anjan V. Thakor, 2004. "Why Do Firms Smooth Earnings?," Finance 0411021, EconWPA.
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