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Did the regulatory changes of 1999 and 2001 affect income smoothing behavior of US banks?

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Abstract

This study examines the impact of the regulatory changes introduced by the Federal Financial Institutions Examination Council (FFIEC) in 1999 and by the Securities and Exchange Commission and FFIEC in 2001 on the income smoothing approaches and mechanisms employed by the United States (US) banking industry. We find that the relationship between previous quarter charge-offs and current quarter recoveries that was prevalent in the 1990’s to be insignificant for homogeneous loans but for heterogeneous loans the relationship became significant in the years following the regulatory changes. Recoveries are positively and significantly associated with the surprise net interest margin or return on assets which implies recoveries are primarily determined by the economic realities of the charged-off loans. The regulatory changes have strengthened the relationship between current quarter recoveries from heterogeneous loans and current quarter charge-offs but for homogeneous loans this relationship weakened insignificantly. The new regulations reduced the surprise gross loan charge-offs suggesting that the enforcement improved the accuracy of the provision as a predictor of next quarter’s gross loan charge-offs.

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Notes

  1. The information is this paragraph is obtained from the Federal Register/Vol. 64, No. 27/Wednesday February 10, 1999/Notices, Pages 6655–6659. https://www.federalregister.gov/articles/2000/06/12/00-14704/uniform-retail-credit-classification-and-account-management-policy.

  2. Open end credit refers to pre-approved loans between the financial institution and the borrowers. The pre-specified amount of the loan must be paid off within a specified date to continue the loan agreement. Credit cards fall into this category. Closed end credit refers to loans that are provided at the beginning of the loan agreement. The principal amount and the financing charges must be paid off within a specified time. Auto loans fall into this category.

  3. We thank an anonymous reviewer for suggesting this analysis. The results improved the paper significantly.

  4. We thank an anonymous reviewer for suggesting this analysis. The results improved significantly.

  5. We thank an anonymous referee for encouraging us to use quarterly data. The results improved significantly.

  6. Dyreng et al. (2014) observe that the effective tax rate has been declining steadily over the 25 years period ending with 2012.

  7. The endogeneity issues arising from omitted variables can be further addressed by using a dynamic panel estimation technique introduced by Arellano and Bond (1991). However, this dynamic panel estimation technique is not a feasible solution for our analysis as all of our tests include a period dummy.

  8. We thank an anonymous reviewer for suggesting this approach.

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Acknowledgements

The authors thank two anonymous referees, the editor, Professor Cheng-Few Lee, Sadok El Ghoul, University of Alberta, and colleagues at the Edwards School of Business, University of Saskatchewan for valuable comments and suggestions.

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Authors and Affiliations

  1. Edwards School of Business, University of Saskatchewan, Saskatoon, Canada

    Abdullah Mamun & George Tannous

  2. Ingram & Yeadon Accountants, Melfort, SK, Canada

    Md Didarul Alam

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  1. Abdullah Mamun
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  2. Md Didarul Alam
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  3. George Tannous
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Correspondence to George Tannous.

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Mamun, A., Alam, M.D. & Tannous, G. Did the regulatory changes of 1999 and 2001 affect income smoothing behavior of US banks?. Rev Quant Finan Acc 52, 1011–1041 (2019). https://doi.org/10.1007/s11156-018-0734-5

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