Research Discussion Papers, Bank of Finland
No 23/2006:
The use of loan loss provisions for capital management, earnings management and signalling by Australian banks
Asokan Anandarajan ()
, Iftekhar Hasan ()
and Cornelia McCarthy ()
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.
Keywords: capital management; earnings management; signalling; Australian banks; (follow links to similar papers)
JEL-Codes: C23; G14; M41; (follow links to similar papers)
52 pages, December 14, 2006
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