Income smoothing management and loan loss provisions in the banking system

Alba Gómez-Ortega, Ana Licerán-Gutiérrez and Maria de la Paz Horno-Bueno

Journal of Risk Finance, 2023, vol. 24, issue 5, 537-553

Abstract: Purpose - The “public interest” of financial institutions was used as an argument to intervene in accounting practices. The Bank of Spain's standard was not compatible with International Accounting Standard (henceforth IAS) 39 and the Spanish banking sector had become one of the most provisioned in Europe. This makes it an interesting case study of the relationship between provisioning and income smoothing. The 2008 financial crisis revealed that provisions were insufficient and a reinforcement regulation process began in 2012. This paper aims to examine whether, since 2012, the Bank of Spain's regulatory effort on impairment accounting standards has induced less income smoothing, correcting its countercyclical effect. Design/methodology/approach - A regression model is applied during the period 2005–2020, to test whether there is a trend change in the correlation between the level of provisions and annual earnings in 2012. Findings - The results show that from 2012 onwards (when the Bank of Spain reinforced the regulation on provisioning), there was a correction in income smoothing behaviour. Originality/value - This study provides empirical evidence that reinforces the claim that accounting policy can affect decision-making accounting practices, in this particular case, at the Bank of Spain.

Keywords: Banking; Loan loss provisions; Smoothing management; Earnings decisions; Cyclicality (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jrfpps:jrf-07-2023-0173

DOI: 10.1108/JRF-07-2023-0173

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