An Empirical Study on Taiwan's Commercial Bank Accruals Management via Loan Loss Provisions and Securities Gains and Losses

Abstract

By identifying and examining the potential discretionary components of Taiwan's commercial bank loss provisions (LLPs) and securities gains and losses (RSGs), this study aims at exploring these banks' accruals management practices. Robust against various sensitivity tests, our empirical findings support the notion that commercial banks strategically increase their LLPs to avoid unfavorable capital adequacy ratios. On the other hand, we find these banks smooth reported earnings via RSGs. Moreover, our evidence is consistent with the hypothesis that LLPs and RSFs serve as substitutes for each other in commercial bank accruals management. However, the extent these banks exercise discretion via either measure varies with domestic capital market performance.
For tests in this study, the specification of simultaneous equations outperforms the competing ordinary least square regression models. Most evidently, the conventional models assume that other potential smoothing variables are exogenous. This limitation would lead to regression errors of inconsistency when discretionary accruals are simultaneously determined. In contrast, with statistical evidence that our potential accruals management measures substitute each other, simultaneous equations model appears to be a more appropriate model.
This study also provides an innovative design for estimating bank loan loss provisions. As compared with an competing designs, our model, which relates commercials bank LLPs to non-performing assets, unsecured loans, accrued acceptances and prior-period loan loss provisions, produces a more efficient predictor for Taiwan's commercial bank LLPs.