Use of Loan Loss Provisions for Capital, Earnings Management and Signalling By Australian Banks

23 Pages Posted: 18 Sep 2007

See all articles by Asokan Anandarajan

Asokan Anandarajan

New Jersey Institute of Technology

Iftekhar Hasan

Fordham University ; Bank of Finland; University of Sydney

Cornelia McCarthy

Columbia University - School of International & Public Affairs (SIPA)

Abstract

This study examines whether and to what extent Australian banks use loan loss provisions (LLPs) for capital, earnings management and signalling. We examine if there were changes in the use of LLPs as a result of 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 we find 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. Furthermore, 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 might 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.

Suggested Citation

Anandarajan, Asokan and Hasan, Iftekhar and McCarthy, Cornelia, Use of Loan Loss Provisions for Capital, Earnings Management and Signalling By Australian Banks. Accounting and Finance, Vol. 47, No. 3, pp. 357-379, September 2007, Available at SSRN: https://ssrn.com/abstract=1014700 or http://dx.doi.org/10.1111/j.1467-629X.2007.00220.x

Asokan Anandarajan (Contact Author)

New Jersey Institute of Technology ( email )

University Heights
School of Management
Newark, NJ 07102

Iftekhar Hasan

Fordham University ( email )

45 COLUMBUS AVENUE
GBA-5TH FLOOR
NEW YORK, NY 10023
United States

Bank of Finland ( email )

P.O. Box 160
Helsinki 00101
Finland

University of Sydney ( email )

P.O. Box H58
Sydney, NSW 2006
Australia

Cornelia McCarthy

Columbia University - School of International & Public Affairs (SIPA) ( email )

420 West 118th Street
New York, NY 10027
United States
+1 212 854 3239 (Phone)

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