The Effect of Covid-19 on Loan Loss Provisions and Earnings Management of European Banks by Merjona Lamaj

Author:Merjona Lamaj
Language: eng
Format: epub
ISBN: 9783658400606
Publisher: Springer Fachmedien Wiesbaden

4.2 Earnings Management Under IFRS 9

The accounting regime plays a significant role in manager’s ability to engage in earnings management. Ewert and Wagenhofer (2005) finds that tighter accounting rules reduce the manager’s ability to engage in accounting earnings management practices. Stricter rules can limit opportunities of managerial discretion, thus resulting in less accounting earnings management. Gebhardt and Novotny-Farkas (2011) finds that after mandatory adoption of IFRS and the imposed restriction to account only for incurred losses European banks engage in less income smoothing.

However, the introduction of IFRS 9 imposed the transition from an incurred to an expected credit loss model. It requires banks to incorporate expected losses in their estimations of loan loss provisions. As a result, the new ECL-model offers more flexibility and expects managers to use judgment when calculating their estimates of loan losses. As a consequence, the new requirements create a great potential for opportunistic behavior. Therefore, given the less stricter rules of the IFRS 9, and in analogy with Gebhardt and Novotny-Farkas (2011), I expect that under the accounting regime of IFRS 9 European banks use income smoothing through LLPs. However, I do not examine any difference with the period prior to IFRS 9. Therefore, my first hypothesis is:

H1: Under IFRS 9 banks use loan loss provisions to smooth income.

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