Assessing Accrual Quality in Financial Institutions

This paper provides a framework for assessing the accrual quality of financial institutions and applies it to commercial banks' loan portfolios. I first develop an accrual reliability categorization for financial institutions and show that existing findings for non-financial firms extend to financial firms. I next demonstrate how supplementing the information in accruals leads to significantly improved assessment of accrual quality. Focusing on commercial banks' loan portfolios, I supplement information in accruals with a measure based on footnote disclosures regarding loan portfolio concentrations and regional economic indicators. I call this measure loan portfolio quality index and show that it further isolates less reliable accruals and significantly improves the forecasting of future earnings and stock returns.