Loan Loss Provisioning and Relationship Banking in Italy: Practices and Empirical Evidence

Abstract

A panel of Italian banks for the period 2006-2012 is used in this paper to examine LLP main determinants. Our analysis also focuses on the determinants of the sub-components of LLP, i.e. provisions associated to Bad Loans and Impaired Loans and Bad Loans and Impaired Loans Coverage Ratio. A specific analysis for cooperative credit banks is provided. We find that Loan Loss provisioning for Italian banks seems to be driven principally by non-discretionary behavior. Economic fluctuations, according to our results, do not play a significant role, nor do signaling and income smoothing. Provisioning strategies for cooperative credit banks also seem to be affected by collateralized loans.

The Impact of Non-performing Loans on Bank Lending Behavior: Evidence from the Italian Banking Sector

“…Bank specific data are obtained from the Bankscope database, and macroeconomic data from the IMF website. The dependent variable, bank behavior (BB), is measured by the growth of gross loan rate for each year, in line with Laeven and Majnoni (2003), Gambacorta and Mistrulli (2004), Curry et al (2006), Berrospide and Edge (2010), Foos et al (2010) and Alessi et al (2014). The independent variables are divided in two groups: macroeconomics and banks' specific variables.…”

Bank loan-loss accounts, income smoothing, capital management, signaling and procyclicality

“…Bank management use its discretion over LLP accounts in the financial statements to achieve various objectives; creating a stable earnings stream is the most important objective of using LLP (income smoothing), as this stability may be perceived as less risky by investors and creditors, resulting to lower borrowing cost and higher stock prices . Also, there are many other reasons that may motivate using LLP; it can be used for capital management purposes; as banks that have a lower level of capital can use provisions to build up a higher reserve buffer (Alessi et al, 2014). Agency theory and compensation theory are other motivations of using LLP because a manager may have incentives to manage earning to increase compensation tied to meet a specific target, or to affect bonus schemes dependent on the level of earnings, or minimizing the probability of being fired.…”

“…The first, considers income smoothing as earning management to mislead investors, the US Securities and Exchange Commission (SEC) adopt this viewpoint and prohibit using "cookie-jar" reserves to smooth income. The second viewpoint considers income smoothing as a necessity; the regulators are interested in reducing bank pro-cyclical behavior (Alessi et al, 2014). Interestingly, Japanese authority (Ministry of Finance) allowed such practices based on the positive consequences of income smoothing because it allow bank managements to build reserves during the good periods so that they can meet regulatory capital requirements and avoid showing losses during bad periods .…”

“…On the other hand, Alessi et al (2014) examined the main determinants of LLP and coverage ratio in Italian banks during the period 2006-2012, and found that neither economic fluctuation nor signaling or income smoothing hypotheses play any significant role in LLP. The results of Cavallo and Majnoni (2001) indicate that banks of non G-10 countries do not involve in income smoothing.…”

“…One year ahead of change in earnings before tax and provisions is used as a measure of signaling in prior literature (Ghosh, 2007;Alessi et al, 2014;Adzis, et al, 2015;Ozili, 2015). A positive relationship is expected between LLP of the current period and income of the subsequent period.…”