IDEAS home Printed from https://ideas.repec.org/p/hal/journl/hal-02429600.html
   My bibliography  Save this paper

Discretionary loan loss provisions and market discipline

Author

Listed:
  • Gaëtan Le Quang

    (EconomiX - EconomiX - UPN - Université Paris Nanterre - CNRS - Centre National de la Recherche Scientifique)

Abstract

Using a panel of 375 American universal commercial banks from 2008 to 2017, we provide empirical evidence that discretionary loan loss provisions increase when market discipline -- proxied by deposit rates -- strengthens. In particular, least-capitalized banks increase more their discretionary loan loss provisions following an increase in deposit rates than other banks do. Loan loss provisions can thus act as a substitute for capital to respond to market discipline. This result partly qualifies the enthusiasm raised by the implementation of forward-looking provisioning models. These models indeed grant great discretion to banks in the setting of loan loss provisions since the valuation method underlying them is subject to uncertainty. In this perspective, regulators should make sure that the implementation of forward-looking provisioning models is not done in a way that would encourage banks to substitute provisions for capital, which would prove detrimental to market discipline.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Gaëtan Le Quang, 2019. "Discretionary loan loss provisions and market discipline," Post-Print hal-02429600, HAL.
    • Handle: RePEc:hal:journl:hal-02429600
    as

    Download full text from publisher

    To our knowledge, this item is not available for download. To find whether it is available, there are three options:
    1. Check below whether another version of this item is available online.
    2. Check on the provider's web page whether it is in fact available.
    3. Perform a search for a similarly titled item that would be available.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Mariathasan, Mike & Merrouche, Ouarda, 2014. "The manipulation of basel risk-weights," Journal of Financial Intermediation, Elsevier, vol. 23(3), pages 300-321.
    2. Kiridaran Kanagaretnam & Gerald J. Lobo & Dong†Hoon Yang, 2004. "Joint Tests of Signaling and Income Smoothing through Bank Loan Loss Provisions," Contemporary Accounting Research, John Wiley & Sons, vol. 21(4), pages 843-884, December.
    3. Bouvatier, Vincent & Lepetit, Laetitia, 2008. "Banks' procyclical behavior: Does provisioning matter?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 18(5), pages 513-526, December.
    4. Maechler, Andrea M. & McDill, Kathleen M., 2006. "Dynamic depositor discipline in US banks," Journal of Banking & Finance, Elsevier, vol. 30(7), pages 1871-1898, July.
    5. Bartholdy, Jan & Boyle, Glenn W. & Stover, Roger D., 2003. "Deposit insurance and the risk premium in bank deposit rates," Journal of Banking & Finance, Elsevier, vol. 27(4), pages 699-717, April.
    6. Shimizu, Katsutoshi, 2009. "Is the information produced in the stock market useful for depositors?," Finance Research Letters, Elsevier, vol. 6(1), pages 34-39, March.
    7. Uchida, Hirofumi & Satake, Mitsuhiko, 2009. "Market discipline and bank efficiency," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 19(5), pages 792-802, December.
    8. Robert M. Bushman, 2016. "Transparency, accounting discretion, and bank stability," Economic Policy Review, Federal Reserve Bank of New York, issue Aug, pages 129-149.
    9. Ahmed, Anwer S. & Takeda, Carolyn & Thomas, Shawn, 1999. "Bank loan loss provisions: a reexamination of capital management, earnings management and signaling effects," Journal of Accounting and Economics, Elsevier, vol. 28(1), pages 1-25, November.
    10. Robert M. Bushman & Christopher D. Williams, 2015. "Delayed Expected Loss Recognition and the Risk Profile of Banks," Journal of Accounting Research, Wiley Blackwell, vol. 53(3), pages 511-553, June.
    11. Stephanou, Constantinos, 2010. "Rethinking market discipline in banking : lessons from the financial crisis," Policy Research Working Paper Series 5227, The World Bank.
    12. Arellano, Manuel & Bover, Olympia, 1995. "Another look at the instrumental variable estimation of error-components models," Journal of Econometrics, Elsevier, vol. 68(1), pages 29-51, July.
    13. Hannan, Timothy H & Hanweck, Gerald A, 1988. "Bank Insolvency Risk and the Market for Large Certificates of Deposit," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 20(2), pages 203-211, May.
    14. Ellis, David M. & Flannery, Mark J., 1992. "Does the debt market assess large banks, risk? : Time series evidence from money center CDs," Journal of Monetary Economics, Elsevier, vol. 30(3), pages 481-502, December.
    15. Blundell, Richard & Bond, Stephen, 1998. "Initial conditions and moment restrictions in dynamic panel data models," Journal of Econometrics, Elsevier, vol. 87(1), pages 115-143, August.
    16. Nier, Erlend & Baumann, Ursel, 2006. "Market discipline, disclosure and moral hazard in banking," Journal of Financial Intermediation, Elsevier, vol. 15(3), pages 332-361, July.
    17. Forssbæck, Jens, 2011. "Ownership structure, market discipline, and banks' risk-taking incentives under deposit insurance," Journal of Banking & Finance, Elsevier, vol. 35(10), pages 2666-2678, October.
    18. Tomy, Rimmy E., 2019. "Threat of entry and the use of discretion in banks’ financial reporting," Journal of Accounting and Economics, Elsevier, vol. 67(1), pages 1-35.
    19. Demirguc-Kunt, Asli & Huizinga, Harry, 2004. "Market discipline and deposit insurance," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 375-399, March.
    20. Beaver, William H. & Engel, Ellen E., 1996. "Discretionary behavior with respect to allowances for loan losses and the behavior of security prices," Journal of Accounting and Economics, Elsevier, vol. 22(1-3), pages 177-206, October.
    21. Windmeijer, Frank, 2005. "A finite sample correction for the variance of linear efficient two-step GMM estimators," Journal of Econometrics, Elsevier, vol. 126(1), pages 25-51, May.
    22. Hess, Kurt & Feng, Gary, 2007. "Is there market discipline for New Zealand non-bank financial institutions?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 17(4), pages 326-340, October.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Hasan, Iftekhar & Jackowicz, Krzysztof & Kowalewski, Oskar & Kozłowski, Łukasz, 2013. "Market discipline during crisis: Evidence from bank depositors in transition countries," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 5436-5451.
    2. Hasan, Iftekhar & Jackowicz, Krzysztof & Kowalewski, Oskar & Kozłowski, Łukasz, 2013. "Market discipline during crisis: Evidence from bank depositors in transition countries," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 5436-5451.
    3. repec:zbw:bofitp:2013_021 is not listed on IDEAS
    4. Bouvatier, Vincent & Lepetit, Laetitia & Strobel, Frank, 2014. "Bank income smoothing, ownership concentration and the regulatory environment," Journal of Banking & Finance, Elsevier, vol. 41(C), pages 253-270.
    5. Konstantinos N. Konstantakis & Despoina Paraskeuopoulou & Panayotis G. Michaelides & Efthymios G. Tsionas, 2021. "Bank deposits and Google searches in a crisis economy: Bayesian non‐linear evidence for Greece (2009–2015)," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 26(4), pages 5408-5424, October.
    6. Doan, Anh-Tuan & Lin, Kun-Li & Doong, Shuh-Chyi, 2020. "State-controlled banks and income smoothing. Do politics matter?," The North American Journal of Economics and Finance, Elsevier, vol. 51(C).
    7. Hegde, Shantaram P. & Kozlowski, Steven E., 2021. "Discretionary loan loss provisioning and bank stock returns: The Role of economic booms and busts," Journal of Banking & Finance, Elsevier, vol. 130(C).
    8. Curcio, Domenico & De Simone, Antonio & Gallo, Angela, 2017. "Financial crisis and international supervision: New evidence on the discretionary use of loan loss provisions at Euro Area commercial banks," The British Accounting Review, Elsevier, vol. 49(2), pages 181-193.
    9. Krzysztof Jackowicz & Oskar Kowalewski & Łukasz Kozłowski, 2018. "Depositors Discipline through Interest Costs during Good and Bad Times: the Role of the Guarantor of Last Resort1," Journal of Financial Services Research, Springer;Western Finance Association, vol. 54(2), pages 179-205, October.
    10. Haq, Mamiza & Faff, Robert & Seth, Rama & Mohanty, Sunil, 2014. "Disciplinary tools and bank risk exposure," Pacific-Basin Finance Journal, Elsevier, vol. 26(C), pages 37-64.
    11. Olszak, Małgorzata & Pipień, Mateusz & Kowalska, Iwona & Roszkowska, Sylwia, 2014. "What drives heterogeneity of loan loss provisions’ procyclicality in the EU?," MPRA Paper 56834, University Library of Munich, Germany.
    12. Wahyoe Soedarmono & Sigid Eko Pramono & Amine Tarazi, 2016. "The procyclicality of loan loss provisions in Islamic banks: Do managerial discretions matter?," Working Papers hal-01281151, HAL.
    13. Vincent Bouvatier & Laetitia Lepetit, 2012. "Effects of Loan Loss Provisions on Growth in Bank Lending: Some International Comparisons," International Economics, CEPII research center, issue 132, pages 91-116.
    14. Tran, Dung Viet & Hassan, M. Kabir & Houston, Reza, 2019. "Activity strategies, information asymmetry, and bank opacity," Economic Modelling, Elsevier, vol. 83(C), pages 160-172.
    15. Aristei, David & Gallo, Manuela, 2019. "Loan loss provisioning by Italian banks: Managerial discretion, relationship banking, functional distance and bank risk," International Review of Economics & Finance, Elsevier, vol. 60(C), pages 238-256.
    16. repec:hal:wpaper:hal-00916674 is not listed on IDEAS
    17. Malgorzata Olszak & Mateusz Pipien & Sylwia Roszkowska & Iwona Kowalska, 2014. "The effects of capital on bank lending in large EU banks – the role of procyclicality, income smoothing, regulations and supervision," Faculty of Management Working Paper Series 52014, University of Warsaw, Faculty of Management.
    18. Di Fabio, Costanza & Ramassa, Paola & Quagli, Alberto, 2021. "Income smoothing in European banks: The contrasting effects of monitoring mechanisms," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 43(C).
    19. de Haan, Leo & van Oordt, Maarten R.C., 2018. "Timing of banks’ loan loss provisioning during the crisis," Journal of Banking & Finance, Elsevier, vol. 87(C), pages 293-303.
    20. Giuliana Birindelli & Paola Ferretti & Giovanni Ferri & Marco Savioli, 2022. "Regulatory reform and banking diversity: reassessing Basel 3," Annals of Finance, Springer, vol. 18(4), pages 429-456, December.
    21. Lukasz Kozlowski, 2018. "The Halo Effect in Banking: Evidence from Local Markets," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 68(5), pages 416-441, October.
    22. Ashim Kumar Kar, 2017. "Income Smoothing, Capital Management and Provisioning Behaviour of Microfinance Institutions: A Study Using Global Panel Data," The European Journal of Development Research, Palgrave Macmillan;European Association of Development Research and Training Institutes (EADI), vol. 29(1), pages 108-126, January.

    More about this item

    Keywords

    [No keyword available];

    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services
    • M4 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:hal:journl:hal-02429600. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: CCSD (email available below). General contact details of provider: https://hal.archives-ouvertes.fr/ .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.