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Bank earnings management through loan loss provisions: a double-edged sword?

Author

Listed:
  • Lars Norden
  • Anamaria Stoian

Abstract

We investigate whether banks use of loan loss provisions (LLPs) to manage the level and volatility of their earnings and examine the implications for bank risk. We find that banks use LLPs to manage the level and volatility of earnings downward when they are abnormally high and when expected dividends are lower than current earnings. Moreover, banks adjust LLPs to avoid fluctuations in their risk-weighted assets. Our findings highlight an important tradeoff in the provisioning for expected and unexpected losses that affects bank risk and profitability.

Suggested Citation

  • Lars Norden & Anamaria Stoian, 2013. "Bank earnings management through loan loss provisions: a double-edged sword?," DNB Working Papers 404, Netherlands Central Bank, Research Department.
  • Handle: RePEc:dnb:dnbwpp:404
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    File URL: https://www.dnb.nl/en/binaries/working%20Paper%20404_tcm47-301517.pdf
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    More about this item

    Keywords

    Loan loss provisions; Bank risk; Earnings smoothing; Discretion; Payout policy;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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