Bank income smoothing in South Africa: role of ownership, IFRS and economic fluctuation

Abstract

Purpose The purpose of this paper is to examine the determinants of the use of loan loss provisions (LLPs) to smooth income by banks in South Africa. More specifically, the authors examine the influence of ownership, IFRS disclosure rules and economic fluctuation on the income smoothing behaviour of South African banks while controlling for the traditional determinants of bank income smoothing via LLPs. Design/methodology/approach The study employs fixed effect regression methodology to estimate the determinants of discretionary LLPs. Findings The authors find that South African banks do not use LLPs to smooth income when they are: under-capitalised, have large non-performing loans and have a moderate ownership concentration. On the other hand, income smoothing is pronounced when South African banks are rather more profitable during economic boom periods, well-capitalised during boom periods and is pronounced among banks that adopt IFRS and among banks with a Big 4 auditor. The authors also find that banks use LLPs for capital management purposes, and bank provisioning is procyclical with economic fluctuations. Practical implications Bank supervisors in South Africa should monitor the bank provisioning practices in South Africa closely to ensure that LLPs are not used as a substitute for bank capital. Banks in South Africa should not use sufficient provisioning as a substitute for sufficient bank capital. Second, the evidence for procyclical bank provisioning shows that provisioning by South African banks reinforce the current state of the economy and might compel bank supervisors in South Africa to consider the adoption of a dynamic provisioning system that is already adopted by bank supervisors in Spain, Peru, Uruguay, Colombia and Bolivia. Originality/value Bank income smoothing is an important issue because it has implications for banking stability and accounting transparency. There are few studies on bank income smoothing for emerging economies particularly in Africa where there are substantial differences in ownership and accounting rules. This is the first South African study to examine the influence of disclosure rules, ownership and economic cycle fluctuations on bank income smoothing behaviour via LLPs.

Good Corporate Governance dan Profitabilitas pada Praktik Income Smoothing

“…Manajer melakukan manipulasi terhadap variabelvariabel akuntansi yang dapat menyebabkan pengungkapan informasi laba pada laporan keuangan tidak diungkapkan sesuai dengan kenyataannya, dengan begitu laba yang dilaporkan akan selalu terlihat stabil (Di Fabio, 2019). Manajer dapat menurunkan tingkat laba pada periode tahun yang dianggap mampu menghasilkan laba yang tinggi, kemudian laba tersebut akan digunakan untuk mengantisipasi perolehan laba pada tahun-tahun berikutnya apabila perolehan laba perusahaan berada pada tingkat yang terlalu rendah (Ozili & Outa, 2018).…”

Income smoothing management and loan loss provisions in the banking system

“…Second, we specifically consider whether the regulatory efforts of the Bank of Spain have contributed to reducing banks' income smoothing practices. Following other smoothing studies that investigate whether tightening of accounting standards that are associated with regulatory changes affect smoothing practices (see, for example: Balla and Rose, 2015; Garc ıa Osma et al, 2019; Kilic et al, 2013;Ozili, 2022b;Ozili and Outa, 2018), we create a dummy variable that reflects whether the effect of earnings on loan loss provision is statistically significant from 2012 onwards. After this moment, the Bank of Spain's regulatory effort began, with the adoption of royal decrees to reinforce the provisioning levels of credit institutions as well as the process of successive changes in the Circulars for convergence towards IFRS 9.…”

“…Consequently, if banks have more loans, a greater provision should be reflected in accounting to anticipate future losses, following the conservatism principle. Then, following several studies in smoothing in the banking literature (see, among others: Garc ıa Osma et al, 2019; Garsva et al, 2012;Kilic et al, 2013;Ozili, 2022a, b;Ozili and Outa, 2018;Peterson and Arun, 2018;Vasilakopoulos et al, 2018), we include NPLs to control the effect of loan default when banks reflect in accounting provisions, expecting a positive relationship between the amount of NPLs and the provision for those loans.…”

Applying the breaks to non-performing loans in Ghana

“…That is, bank LLPs are a positive function of NPLs up to a limit; thereafter it does not affect NPLs. In another study, Ozili and Outa (2018) examined what drives the use of LLPs by banks in South Africa. Estimating the determinants of discretionary LLPs employing the fixed effects regression technique, the authors pointed to the fact that banks do not hold LLPs to smooth their income when they have large NPLs and are undercapitalized.…”