Loan portfolio information and accounting in banks

This dissertation deals with accounting choices related to loan loss reserves in banks. It is made up of three papers---a literature survey, a paper discussing theories of earnings management in banks, and an empirical paper testing for the impact of changes in regulation on accrual management. The papers focus on the loan loss allowance and loan loss provisions accounts and their role in earnings and capital management.;The literature survey, in part, summarizes evidence from past studies on the security market's reaction to an increase in discretionary loan loss provisions. Among reasons for the positive market reaction observed in some of the studies is the signaling motivation and the earnings smoothing motivation. The theory paper differentiates between these two motivations of the bank manager to manage earnings. It analyzes the different components of a possible signaling model and concludes that it is possible for a better quality bank to signal the quality of the loan portfolio without imitation by a lower quality bank.;The literature survey also summarizes studies suggesting that bank managers manage accruals to maintain regulatory capital. The empirical paper tests the impact of changes in capital regulations on accrual management in banks and investigates if managers respond quickly to regulatory changes. It compares the association between discretionary loan loss allowance and capital and income variables in the period before 1989 and after the regulations were finally implemented in 1991. The results show that during 1992--1995, regulatory capital ratios are not as important in determining the discretionary loan loss allowance. Low-capital banks do not react significantly to regulatory changes. Well-capitalized banks are able to adjust faster and significantly to regulatory changes. Banks with large holdings of long-term loans such as real estate loans and small holdings of commercial loans react similarly to regulatory changes.;The results do not provide any evidence supporting earnings management before and after regulatory changes. This result holds for banks with predominant holdings of real estate loans, consumer loans and commercial loans as well as well-capitalized banks.