The predictive ability of loan loss provisions in banks within EU following IFRS - The effect of country specific factors

Abstract

In recent years, an increased attention has been devoted to banks’ loan loss provisions and actual losses. The incurred loss model under IFRS (IAS 39) has been criticized for leading to less timely loan loss recognition. In this study we compare the predictive ability of loan loss provisions between different countries following IFRS. IFRS was developed with the purpose of harmonizing accounting standards across countries, despite this the existence of country differences have been observed in previous studies (Manganaries, Beccalli & Dimitropoulos, 2017). We interpret country specific differences by observing countries legal origin, culture, level of enforcement and level of earnings management. We find that the predictive ability of loan loss provisions in banks varies between different countries within Europe, where the factors representing the clusters can be identified as explanatory variables. Following the financial crisis, the model’s late loss recognition has been pointed out as one of the reasons as to why the financial crisis occurred. For that reason we also examine if the predictive ability of loan loss provisions differs between countries, and if this changes during the financial crisis compared the period before and after. We conclude that there are changes in the predictive ability during the financial crisis, indicating that the quality of accounting changes depending on the state of the economy. Our results have implications for users of the financial information and should thereby be considered by standard setters. This will primarily be important when implementing the new standard, IFRS 9, to avoid country specific differences and increase harmonization among countries.