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Signalling by banks using loan loss provisions: the case of the European Union

Author

Listed:
  • Stergios Leventis
  • Panagiotis E. Dimitropoulos
  • Asokan Anandarajan
Abstract
Purpose - The purpose of this paper is to investigate whether bank managers of countries within the European Union (EU) engage in signalling, especially after implementation of international financial reporting standards (IFRS) commencing 2005. Design/methodology/approach - “Signaling” is the use of loan loss provisions (LLPs) to convey signals of fiscal prudence and future profitability to investors. The authors use data from 18 countries across the EU covering the pre and post IFRS regimes and apply univariate and multivariate tests in order to test signaling behavior under both accounting regimes. Findings - The findings indicate insufficient evidence that financially healthy banks engage in signaling behavior. However, banks facing financial distress appear to engage in aggressive signaling relative to healthy banks. Finally, the propensity to engage in signaling behavior is more pronounced for financially distressed banks in the post IFRS regime. While IFRS, under IAS 39 sort to mitigate the discretionary component of LLPs, our finding may be attributable to lax enforcement of IFRS. Practical implications - The findings have implications for both investors and regulators. Investors should be aware that troubled banks engage in signaling to convey positive information about their future prospects. Regulators should be aware that financially stressed banks have a greater propensity to engage in signaling and need to ensure that the provisions of IFRS (which attempts to limit discretion in estimating LLPs) are enforced more stringently. Originality/value - The paper contributes to the growing literature on bank signaling in a number of ways. First, the authors use a sample from 18 countries within the EU which has not been done before. Second, unlike prior studies which only examined healthy banks, the authors also include financially distressed banks in the sample. Third, the authors examine signaling behavior in the pre and post IFRS regimes to understand the influence of IFRS on the propensity to engage in signaling by bank managers.

Suggested Citation

  • Stergios Leventis & Panagiotis E. Dimitropoulos & Asokan Anandarajan, 2012. "Signalling by banks using loan loss provisions: the case of the European Union," Journal of Economic Studies, Emerald Group Publishing Limited, vol. 39(5), pages 604-618, September.
    • Handle: RePEc:eme:jespps:v:39:y:2012:i:5:p:604-618
    DOI: 10.1108/01443581211259509
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    References listed on IDEAS

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    3. Bouvatier, Vincent & Lepetit, Laetitia & Strobel, Frank, 2014. "Bank income smoothing, ownership concentration and the regulatory environment," Journal of Banking & Finance, Elsevier, vol. 41(C), pages 253-270.
    4. Ozili, Peterson K, 2015. "Loan Loss Provisioning, Income Smoothing, Signaling, Capital Management and Procyclicality: Does IFRS Matter? Empirical Evidence from Nigeria," MPRA Paper 68350, University Library of Munich, Germany.
    5. Mohsen Bahmani-Oskooee & Ruixin Zhang, 2015. "On the impact of financial development on income distribution: time-series evidence," Applied Economics, Taylor & Francis Journals, vol. 47(12), pages 1248-1271, March.
    6. Mohammad Abedalrahman Alhmood & Hasnah Shaari & Redhwan Al-dhamari, 2020. "CEO Characteristics and Real Earnings Management in Jordan," International Journal of Financial Research, International Journal of Financial Research, Sciedu Press, vol. 11(4), pages 255-266, July.
    7. Peterson, Ozili K. & Arun, Thankom G., 2018. "Income smoothing among European systemic and non-systemic banks," The British Accounting Review, Elsevier, vol. 50(5), pages 539-558.
    8. Albulena Shala & Skender Ahmeti & Rezearta Sh. Perri, 2017. "A Review on Accounts Manipulation via Loan Loss Provisions to Manage Earnings and Impact of IFRS," EuroEconomica, Danubius University of Galati, issue 1(36), pages 113-121, May.
    9. Danisman, Gamze Ozturk & Demir, Ender & Ozili, Peterson, 2021. "Loan loss provisioning of US banks: Economic policy uncertainty and discretionary behavior," International Review of Economics & Finance, Elsevier, vol. 71(C), pages 923-935.
    10. Ozili, Peterson K, 2020. "Bank loan loss provisioning during election years: cross-country evidence," MPRA Paper 96639, University Library of Munich, Germany.
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    12. Ozili, Peterson K, 2019. "Bank loan loss provisions, risk-taking and bank intangibles," MPRA Paper 90273, University Library of Munich, Germany.

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