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

Posted: 16 Oct 2007

See all articles by Asokan Anandarajan

Asokan Anandarajan

New Jersey Institute of Technology

Cornelia McCarthy

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

Iftekhar Hasan

Fordham University ; Bank of Finland; University of Sydney

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

JEL Classification: C23, G14, M41

Suggested Citation

Anandarajan, Asokan and McCarthy, Cornelia and Hasan, Iftekhar, The Use of Loan Loss Provisions for Capital Management, Earnings Management and Signalling By Australian Banks. Bank of Finland Research Discussion Paper No. 23/2006, Available at SSRN: https://ssrn.com/abstract=1019949 or http://dx.doi.org/10.2139/ssrn.1019949

Asokan Anandarajan

New Jersey Institute of Technology ( email )

University Heights
School of Management
Newark, NJ 07102

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)

Iftekhar Hasan (Contact Author)

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

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