Bank earnings management through loan loss provisions

We investigate whether banks use of loan loss provisions (LLPs) to manage the level and volatility of their earnings and examine the implications for bank risk. We find that banks use LLPs to manage the level and volatility of earnings downward when they are abnormally high and when expected dividends are lower than current earnings. Moreover, banks adjust LLPs to avoid fluctuations in their risk-weighted assets. Our findings highlight an important trade- off in the provisioning for expected and unexpected losses that affects bank risk and profitability.

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