۱- Introduction

۲- Conceptual framework and literature

۳- Hypothesis development

۴- Data and methodology

۵- Results

۶- Conclusion

References

Abstract

There is scant research on the financial reporting behaviour of global systemically-important banks (G-SIBs) and non-global systemically-important banks (non-G-SIBs). We examine the link between financial reporting and financial system stability given the understanding that income smoothing is a stability mechanism for banks. We empirically examine whether the way G-SIBs use loan loss provisions (LLPs) to smooth income differ compared to non-G-SIBs and the incentive to do so. We examine 231 European banks and find that income smoothing is pronounced among G-SIBs in the post-crisis period and pronounced among non-G-SIBs in the pre-crisis period. Also, G-SIBs exhibit greater income smoothing when they: (i) have substantial non-performing loans, (ii) are more profitable and meet/exceed minimum regulatory capital ratios (iii) engage in forward-looking loan-loss provisioning and during recessionary periods. The implication of our findings is that capital regulation and abnormal economic fluctuations create incentives for systemic banks to use accounting numbers (loan loss provisions) to smooth income, which also align with the financial system stability objective of bank regulators. Our findings are useful to accounting standard setters in their evaluation of the role of reported accounting numbers for financial system stability, given the current regulatory environment in Europe which focuses on systemic banks.

Introduction

Systemic banks (also known as G-SIBs or SIFIs) are defined as “financial institutions whose distress or disorderly failure, because of their size, complexity and systemic interconnectedness, would cause significant disruption to the wider financial system and economic activity” (FSB, Policy measures to address SIFIs, 11/2011). Systemic banks (also known as G-SIBs or SIFIs) are defined as “financial institutions whose distress or disorderly failure, because of their size, complexity and systemic interconnectedness, would cause significant disruption to the wider financial system and economic activity” (FSB, Policy measures to address SIFIs, 11/2011). The severity of the 2008 global financial crisis put the “systemic” or “too big to fail” issue to the forefront due to the potentially disruptive impact on financial stability of the failure of a large financial institution which was highlighted by the collapse of Lehman Brothers (Mesnard et al, 2017)1 . At global level, regulators and policy makers around the world agreed quickly that the issue of financial firms perceived as too big, too complex or too interconnected to fail should become a regulatory priority; the Financial Stability Board (FSB) proposed possible measures to address the ‘too big to fail’ problems associated with systemically important financial institutions and published an initial group of global systemically important banks (G-SIBs), using a methodology developed by the Basel Committee on Banking Supervision2 (Mesnard et al, 2017). At bank level, banks take some measures to achieve bank stability, and one of such measures is stability through financial reporting. One financial reporting property that align with stability objectives is earnings management. Earnings management can have positive or negative effects for financial system stability, and this effect depends on the type of earnings management employed, which also depends on the regulatory classification of firms used by regulators to place stricter regulatory oversight on some firms compared to other firms. Income smoothing is a type of earnings management which can have positive effects for financial system stability if it helps banks remain stable by reducing earnings volatility or could have negative effects by contributing to systemic crash and distress risk (Bushman and Williams, 2015; Ma and Song, 2016). After the 2007 global financial crisis, a joint consultation with the Financial Stability Board (FSB) and the Basel Committee for Banking Supervision (BCBS), using a common methodology3 , produced a list of global systemic banks (GSIBs) and non-global systemic banks (non-G-SIBs) to identify financial institutions that pose the greatest risk to the financial system and whose systemic properties exacerbated the financial crisis during their near collapse in 2008.