Does the New European Banking Regulation discourage Earnings Management?

Abstract

In the recent past, the financial crisis has shown important lacks in the EU regulation relating to the banking sector, making the introduction of a unified regulatory framework necessary. Since June 2009 the European Council has recommended a "Single Rulebook", that is a unique and harmonizing discipline applicable to all financial institutions in the Single Market, become effective on January 2014. This prudential discipline requires much more minimum capital, liquidity and information transparency and it defines format and minimum standards of contents.The aim of this research is to investigate the relation between the new mandatory disclosure and earnings management policies in banking sector realized through Loan Loss Provisions (LLP), the component of income statement mainly subject to manipulations, especially in form of earnings smoothing. Because the new integrated regulatory framework requires a more transparent disclosure, we expected that accruals manipulation (basically LLP) could be discouraged. The empirical analysis is based on a sample of 116 listed European banks over the period prior (2011-2012-2013) and after (2014-2015-2016) the effective date of the Single Rulebook. The evidence confirm our hypothesis suggesting that this banking reform discourages earnings manipulation and improves earnings quality, making financial reporting more useful for investors. The results are important to the regulatory institutions (such as European Union and European Central Bank) supporting more stringent discipline introduced by Basel III.

Prevention Of Earnings Management Behavior In The Banking Industry Through Government Regulations

“…This has an impact on minimum capital requirements, higher liquidity and information transparency. Di Martino et al (2017) used 116 European banks that implemented the Single Book Rule policy, namely before the 2011-2013 period and after the 2014-2016 period. The results obtained show that government regulations through LLP rules are able to inhibit earnings manipulation and improve earnings quality.…”

“…According to Di Martino et al (2017) governments in Europe since 2014 have implemented a new banking regulatory framework called the Single Rulebook. The aim of the new regulation is to regulate all financial institutions in the single market so that they can apply the principles of prudence and transparency in managing their business.…”

“…LLP assists bank managers in dealing with future declines in credit quality (Sari and Widaninggar, 2021). In several research results (Abaoub and Gamra, 2013;Di Martino et al, 2017;Sari and Widaninggar, 2020) it was found that LLP is used by bank managers in managing earnings in various countries, because the determination of LLP uses direct judgment by bank managers which is dominated by higher in subjectivity.…”

Connecting earnings management and corporate social responsibility: A renewed perspective

“…Dechow, Ge, & Schrand () define “earnings quality” indirectly, arguing that “higher quality earnings provide more information about the features of a firm's financial performance that are relevant to a specific decision made by a specific decision maker” (Dechow, Ge, & Schrand, , p. 344). Di Martino, Dicuonzo, Galeone, & Dell'Atti (, p. 47) stress that “earnings quality is linked, with a negative connotation, to the one of earnings management.”…”