1. bookVolume 10 (2021): Issue 1 (January 2021)
Journal Details
License
Format
Journal
eISSN
2336-9205
First Published
11 Mar 2014
Publication timeframe
3 times per year
Languages
English
access type Open Access

The Impact of Earnings variability and Regulatory Measures on Income Smoothing: Evidence from Panel Regression

Published Online: 26 Jan 2021
Volume & Issue: Volume 10 (2021) - Issue 1 (January 2021)
Page range: 183 - 201
Journal Details
License
Format
Journal
eISSN
2336-9205
First Published
11 Mar 2014
Publication timeframe
3 times per year
Languages
English
Abstract

This study investigates the impact of variability in earnings, stringent regulatory measures and the trend of extending loans while keeping in view deposit ratio on income smoothening practices for a sample of 20 commercial banks listed on the Pakistan Stock Exchange (PSX) from the year 2010 to 2017. The likelihood of smoothing activities is measured through its widely used proxy, i.e. loan loss provisions (LLPs). Moreover, earnings before tax and provisions (EBTP) and loan to deposit ratio (LD) have been incorporated to determine the impact of earnings and loans to deposit ratio on income smoothening. We find that commercial banks are less likely to manage earnings through smoothening practices, which shows that commercial banks adhere to regulatory restrictions. This is further supported by the fact that income smoothing activities decrease as a result of the increase in capital adequacy ratios after the imposition of stringent rules, which exert greater regulatory pressure on banks, whereas the pace of income smoothing increases as a result of an increase in loans to deposit ratio, which reveals that banks take credit risk but manage within the ambit of regulatory restrictions. Based on the findings, we argue that the imposition of regulatory restrictions through the State Bank of Pakistan (SBP) has not only discouraged income smoothening through loan loss provisions but also enhances reporting quality. The results of this study provide useful insights for investors, creditors and stakeholders.

Keywords

JEL Classification

1. Adzis, Abdul A., Tripe, D. W., & Dunmore, P. (2016). IAS 39, income smoothing, and pro-cyclicality: evidence from Hong Kong banks. Journal of Financial Economic Policy, 8(1), 80–94.10.1108/JFEP-05-2015-0026Search in Google Scholar

2. Abdul Wahab, H., Saiti, B., Rosly, S. A., & Masih, A. M. M. (2017). Risktaking behavior and capital adequacy in a mixed banking system: new evidence from Malaysia using dynamic OLS and two-step dynamic system GMM estimators. Emerging Markets Finance and Trade, 53(1), 180–198.10.1080/1540496X.2016.1162151Search in Google Scholar

3. Acar, M., & Ipci, M. O. (2015). Loan loss provisions and income-smoothing hypothesis: Experience from Turkish banking sector. Journal of Accounting, 5(1), 118–135.Search in Google Scholar

4. Adzis, Abdul A., Tripe, D., & Dunmore, P. (2010). International Financial Reporting Standards (IFRS) and income smoothing activities of banks: Evidence from Australia and New Zealand commercial banks.10.2139/ssrn.1717307Search in Google Scholar

5. Agarwal, S., Chomsisengphet, S., Liu, C., & Rhee, S. G. (2007). Earnings management behaviors under different economic environments: Evidence from Japanese banks. International Review of Economics & Finance, 16(3), 429–443.10.1016/j.iref.2005.08.003Search in Google Scholar

6. Ahmed, A. S., Takeda, C., & Thomas, S. (1999). Bank loan loss provisions: a reexamination of capital management, earnings management and signaling effects. Journal of accounting and economics, 28(1), 1–25.10.1016/S0165-4101(99)00017-8Search in Google Scholar

7. Ayub, H., & Javeed, A. (2016). Impact and Implications of Capital Adequacy Ratio on the Financing Behaviour: Evidence from Islamic Banks in Pakistan. Journal of Islamic Business and Management Vol, 6(1).Search in Google Scholar

8. Balboa, M., López-Espinosa, G., & Rubia, A. (2013). Nonlinear dynamics in discretionary accruals: An analysis of bank loan-loss provisions. Journal of Banking & Finance, 37(12), 5186–5207.10.1016/j.jbankfin.2013.05.020Search in Google Scholar

9. Bancaria, C. d. B. p. l. v. (2004). International convergence of capital measurement and capital standards: a revised framework: Bank for International Settlements.Search in Google Scholar

10. Bayar, Y. (2019). Macroeconomic, Institutional and Bank-Specific Determinants of Non-Performing Loans in Emerging Market Economies: A Dynamic Panel Regression Analysis. Journal of Central Banking Theory and Practice, 8(3), 95–110.10.2478/jcbtp-2019-0026Search in Google Scholar

11. Beatty, A., Chamberlain, S. L., & Magliolo, J. (1995). Managing financial reports of commercial banks: The influence of taxes, regulatory capital, and earnings. Journal of accounting research, 231–261.10.2307/2491487Search in Google Scholar

12. Beaver, W. H., & Engel, E. E. (1996). Discretionary behavior with respect to allowances for loan losses and the behavior of security prices. Journal of accounting and economics, 22(1–3), 177–206.10.1016/S0165-4101(96)00428-4Search in Google Scholar

13. Boulila Taktak, N., Ben Slama Zouari, S., & Boudriga, A. (2010). Do Islamic banks use loan loss provisions to smooth their results? Journal of Islamic Accounting and Business Research, 1(2), 114–127.10.1108/17590811011086714Search in Google Scholar

14. Bouvatier, V., & Lepetit, L. (2008). Banks’ procyclical behavior: Does provisioning matter? Journal of international financial markets, institutions and money, 18(5), 513–526.10.1016/j.intfin.2007.07.004Search in Google Scholar

15. Bryce, C., Dadoukis, A., Hall, M., Nguyen, L., & Simper, R. (2015). An analysis of loan loss provisioning behaviour in Vietnamese banking. Finance Research Letters, 14, 69–75.10.1016/j.frl.2015.05.014Search in Google Scholar

16. Caporale, G. M., Alessi, M., Di Colli, S., & Lopez, J. S. (2015). Loan loss provision: some empirical evidence for Italian banks.10.2139/ssrn.2591834Search in Google Scholar

17. Collins, J. H., Shackelford, D. A., & Wahlen, J. M. (1995). Bank differences in the coordination of regulatory capital, earnings, and taxes. Journal of accounting research, 263–291.10.2307/2491488Search in Google Scholar

18. Dong, X., Liu, J., & Hu, B. (2012). Research on the relationship of commercial bank’s loan loss provision and earning management and capital management. Journal of Service Science and Management, 5(02), 171.10.4236/jssm.2012.52021Search in Google Scholar

19. Dushku, E. (2016). Some Empirical Evidence of Loan Loss Provisions for Albanian Banks. Journal of Central Banking Theory and Practice, 5(2), 157–173.10.1515/jcbtp-2016-0016Search in Google Scholar

20. Fernando, W., & Ekanayake, E. (2015). Do commercial banks use loan loss provisions to smooth their income? Empirical evidence from Sri Lankan commercial banks. Journal of Finance and Bank Management, 3(1), 167–179.Search in Google Scholar

21. Fonseca, A. R., & Gonzalez, F. (2008). Cross-country determinants of bank income smoothing by managing loan-loss provisions. Journal of Banking & Finance, 32(2), 217–228.10.1016/j.jbankfin.2007.02.012Search in Google Scholar

22. Francis, J., LaFond, R., Olsson, P. M., & Schipper, K. (2004). Costs of equity and earnings attributes. The accounting review, 79(4), 967–1010.10.2308/accr.2004.79.4.967Search in Google Scholar

23. Ghafar b. Ismail, A., Shah Shaharudin, R., & Samudhram, A. R. (2005). Do Malaysian banks manage earnings through loan loss provisions? Journal of financial reporting and accounting, 3(1), 41–47.10.1108/19852510580000336Search in Google Scholar

24. Greenawalt, M. B., & Sinkey, J. F. (1988). Bank loan-loss provisions and the income-smoothing hypothesis: an empirical analysis, 1976–1984. Journal of financial services research, 1(4), 301–318.10.1007/BF00235201Search in Google Scholar

25. Kanagaretnam, K., Krishnan, G. V., & Lobo, G. J. (2009). Is the market valuation of banks’ loan loss provision conditional on auditor reputation? Journal of Banking & Finance, 33(6), 1039–1047.10.1016/j.jbankfin.2008.10.013Search in Google Scholar

26. Kanagaretnam, K., Lobo, G. J., & Mathieu, R. (2003). Managerial incentives for income smoothing through bank loan loss provisions. Review of Quantitative Finance and Accounting, 20(1), 63–80.10.1023/A:1022187622780Search in Google Scholar

27. Kanagaretnam, K., Lobo, G. J., & Mathieu, R. (2004). Earnings management to reduce earnings variability: evidence from bank loan loss provisions. Review of Accounting and Finance, 3(1), 128–148.10.1108/eb043399Search in Google Scholar

28. Kanagaretnam, K., Lobo, G. J., & YANG, D. H. (2004). Joint tests of signaling and income smoothing through bank loan loss provisions. Contemporary Accounting Research, 21(4), 843–884.10.1506/UDWQ-R7B1-A684-9ECRSearch in Google Scholar

29. Kim, M.-S., & Kross, W. (1998). The impact of the 1989 change in bank capital standards on loan loss provisions and loan write-offs. Journal of accounting and economics, 25(1), 69–99.10.1016/S0165-4101(98)00015-9Search in Google Scholar

30. Koju, L., Koju, R., & Wang, S. (2018). Macroeconomic and Bank-Specific Determinants of Non-Performing Loans: Evidence from Nepalese Banking System. Journal of Central Banking Theory and Practice, 7(3), 111–138.10.2478/jcbtp-2018-0026Search in Google Scholar

31. Kola, F., Gjipali, A., & Sula, E. (2019). Commercial Bank Performance and Credit Risk in Albania. Journal of Central Banking Theory and Practice, 8(3), 161–177.10.2478/jcbtp-2019-0029Search in Google Scholar

32. Kwak, W., Lee, H.-Y., & Eldridge, S. W. (2009). Earnings management by Japanese bank managers using discretionary loan loss provisions. Review of Pacific Basin Financial Markets and Policies, 12(01), 1–26.10.1142/S0219091509001526Search in Google Scholar

33. Lim, C. Y., & Yong, K. O. (2017). Regulatory pressure and income smoothing by banks in response to anticipated changes to the Basel II Accord. China Journal of Accounting Research, 10(1), 9–32.10.1016/j.cjar.2016.08.003Search in Google Scholar

34. Mashamba, T., & Magweva, R. (2019). Basel III LCR Requirement and Banks’ Deposit Funding: Empirical Evidence from Emerging Markets. Journal of Central Banking Theory and Practice, 8(2), 101–128.10.2478/jcbtp-2019-0016Search in Google Scholar

35. Ozili, P. K., & Outa, E. (2017). Bank loan loss provisions research: A review. Borsa Istanbul Review, 17(3), 144–163.10.1016/j.bir.2017.05.001Search in Google Scholar

36. Pérez, D., Salas-Fumás, V., & Saurina, J. (2006). Earnings and capital management in alternative loan loss provision regulatory regimes (No. 0614).Search in Google Scholar

37. Rashid, A., & Khalid, M. (2018). An Assessment Of Bank Capital Effects On Bank-Risk-Taking In Pakistan. Pakistan Journal of Applied Economics, 28(2), 213–234.Search in Google Scholar

38. Sakti, M. R. P., Tareq, M. A., Saiti, B., & Akhtar, T. (2017). Capital structure of Islamic banks: a critical review of theoretical and empirical research. Qualitative Research in Financial Markets, 9(3), 292–308.10.1108/QRFM-01-2017-0007Search in Google Scholar

39. Shaharudin, R. S. (2004). A review on accounts manipulation via loan loss provisions to manage regulatory capital and earnings along business cycle. Jurnal Ekonomi Malaysia, 38, 99–123.Search in Google Scholar

40. Shawtari, F. A., Saiti, B., Razak, S. H. A., & Ariff, M. (2015). The impact of efficiency on discretionary loans/finance loss provision: A comparative study of Islamic and conventional banks. Borsa Istanbul Review, 15(4), 272–282.10.1016/j.bir.2015.06.002Search in Google Scholar

41. Skała, D. (2015). Saving on a Rainy Day? Income Smoothing and Procyclicality of Loan-Loss Provisions in Central European Banks. International Finance, 18(1), 25–46.10.1111/1468-2362.12058Search in Google Scholar

42. Topbaş, T. N. (2018). Are Capital Ratios Procyclical? Evidence from Turkish Banking Data. Journal of Central Banking Theory and Practice, 7(3), 159–180.10.2478/jcbtp-2018-0028Search in Google Scholar

43. Wahlen, J. M. (1994). The nature of information in commercial bank loan loss disclosures. Accounting Review, 455–478.Search in Google Scholar

44. Zoubi, T. A., & Al-Khazali, O. (2007). Empirical testing of the loss provisions of banks in the GCC region. Managerial Finance, 33(7), 500–511.10.1108/03074350710753771Search in Google Scholar

Recommended articles from Trend MD

Plan your remote conference with Sciendo