Abstract

This study has a dual purpose. The first part explores whether business cycle will enhance or weaken the effect of banks' earnings on provisioning. The evidence shows that whereas with a buoyant economy but negative growth in banks' earnings, management will exhibit an inclination to reduce loan loss provisions. The income-smoothing effect tends to hold and to be less affected by business cycles. By contrast, when the economy follows a downward trend and the banks suffer losses, management evidently increases loan loss provisions. In such cases, the reversed income-smoothing effect holds and is strongly influenced by business cycles. The second part of this study investigates whether country-wise bank regulations influence banks' loan loss provisions. The evidence shows that when the economy and the banks' earnings more in the same direction, exhibiting either steady positive growth or negative growth, the intensified income-smoothing effect still exists. In other scenarios that we tested, when the economy remains prosperous but banks' earnings are in the downward trends, not only intensified income-smoothing effect holds, but also strongly influenced by business cycles. This explains why bank regulations regarding loan loss provisions across countries do have an impact on the banks' provisioning behavior.