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The use of loan loss provisions for capital management, earnings management and signalling by Australian banks

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Author Info

  • Anandarajan , Asokan

    ()
    (School of Management, New Jersey Institute of Technology)

  • Hasan , Iftekhar

    ()
    (Rensselaer Polytechnic Institute, Bank of Finland Research)

  • McCarthy , Cornelia

    ()
    (School of International and Public Affairs, Columbia University)

Abstract

The objective of this study is to examine whether and to what extent Australian banks use loan loss provisions (LLPs) for capital management, earnings management and signalling. We examine if there were changes in the use of LLPs due to the implementation of banking regulations consistent with the Basel Accord of 1988 which made loan loss reserves no longer part of Tier I capital in the numerator of the capital adequacy ratio. We find some evidence to indicate that Australian banks use LLPs for capital management, but no evidence of a change in this behaviour after the implementation of the Basel Accord. Our results indicate that banks in Australia use LLPs to manage earnings. Further, listed commercial banks engage more aggressively in earnings management using LLPs than unlisted commercial banks. We also find that earnings management behaviour is more pronounced in the post-Basel period. Overall, we find a significant understating of LLPs in the post-Basel period relative to the pre-Basel period. This indicates that reported earnings may not reflect the true economic reality underlying those numbers. Finally, Australian banks do not appear to use LLPs for signalling future intentions of higher earnings to investors.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0623netti.pdf
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Bibliographic Info

Paper provided by Bank of Finland in its series Research Discussion Papers with number 23/2006.

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Length: 52 pages
Date of creation: 14 Dec 2006
Date of revision:
Handle: RePEc:hhs:bofrdp:2006_023

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Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/
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Keywords: capital management; earnings management; signalling; Australian banks;

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  1. Williams, Barry, 1998. "Factors affecting the performance of foreign-owned banks in Australia: A cross-sectional study," Journal of Banking & Finance, Elsevier, vol. 22(2), pages 197-219, February.
  2. Wetmore, Jill L. & Brick, John R., 1994. "Loan-loss provisions of commercial banks and adequate disclosure: A note," Journal of Economics and Business, Elsevier, vol. 46(4), pages 299-305, October.
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  8. 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.
  9. John Core, 2002. "Estimating the Value of Employee Stock Option Portfolios and Their Sensitivities to Price and Volatility," Journal of Accounting Research, Wiley Blackwell, vol. 40(3), pages 613-630, 06.
  10. Moyer, Susan E., 1990. "Capital adequacy ratio regulations and accounting choices in commercial banks," Journal of Accounting and Economics, Elsevier, vol. 13(2), pages 123-154, July.
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  12. 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.
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