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

  • 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)

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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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
Contact details of provider: Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/

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  1. 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.
  2. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
  3. 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.
  4. 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.
  5. 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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  8. 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.
  9. Scholes, Myron S & Wilson, G Peter & Wolfson, Mark A, 1990. "Tax Planning, Regulatory Capital Planning, and Financial Reporting Strategy for Commercial Banks," Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 625-50.
  10. Morris Goldstein, 1997. "Case for an International Banking Standard, The," Peterson Institute Press: Policy Analyses in International Economics, Peterson Institute for International Economics, number pa47, 03.
  11. Fama, Eugene F, 1980. "Agency Problems and the Theory of the Firm," Journal of Political Economy, University of Chicago Press, vol. 88(2), pages 288-307, April.
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