Does Basel II Affect the Market Valuation of Discretionary Loan Loss Provisions?

Posted: 10 Oct 2017

See all articles by Malika Hamadi

Malika Hamadi

Surrey Business School

Andréas Heinen

University of Cergy-Pontoise - THEMA

Stefan Linder

ESSEC Business School

Vlad-Andrei Porumb

University of Manchester - Alliance Manchester Business School

Date Written: May 31, 2016

Abstract

We use a sample of banks from 24 European countries to investigate whether the adoption of the Basel II Capital Accord in 2008 affects the market valuation of discretionary loan loss provisions (DLLPs). Although Basel II lowers the incentives of internal ratings- based (IRB) banks to recognize income-increasing DLLPs in an opportunistic manner, it has no such impact on the remaining banks, which adopt the Standardized methodology. We use this setup in a difference-in-difference (DiD) design, where Standardized banks act as a control group. Our evidence supports the three hypotheses that, for IRB relative to Standardized banks, Basel II is associated with (i) less income-increasing DLLPs and (ii) less income-smoothing via DLLPs, which enhances the informational content of DLLPs about future loan losses and leads to (iii) higher market valuation of DLLPs. Our findings are timely and have policy implications for future regulatory developments in the banking industry.

Keywords: Basel II, Market Valuation, Income Smoothing, Loan Loss Provisions, Regulatory Capital, Banks, Europe

JEL Classification: C33, K20, M42, M48

Suggested Citation

Hamadi, Malika and Heinen, Andréas and Linder, Stefan and Porumb, Vlad-Andrei, Does Basel II Affect the Market Valuation of Discretionary Loan Loss Provisions? (May 31, 2016). Journal of Banking and Finance, Vol. 70, 2016, Available at SSRN: https://ssrn.com/abstract=3048846

Malika Hamadi

Surrey Business School

Surrey Business School
Guildford, Surrey GU2 7XH
United Kingdom

Andréas Heinen

University of Cergy-Pontoise - THEMA ( email )

33 boulevard du port
F-95011 Cergy-Pontoise Cedex, 95011
France

Stefan Linder

ESSEC Business School ( email )

3 Avenue Bernard Hirsch
CS 50105 CERGY
CERGY, CERGY PONTOISE CEDEX 95021
France

HOME PAGE: http://www.essec.edu

Vlad-Andrei Porumb (Contact Author)

University of Manchester - Alliance Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

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