Neila Boulila Taktak, Sarra Ben Slama Zouari and AbdelKader Boudriga
The paper seeks to examine income smoothing practices in Islamic banks. It first focuses on detecting income smoothing practices. It then seeks to test whether loan loss…
Abstract
Purpose
The paper seeks to examine income smoothing practices in Islamic banks. It first focuses on detecting income smoothing practices. It then seeks to test whether loan loss provisions (LLPs) are used for earnings management purposes.
Design/methodology/approach
The paper explores income smoothing practices on a sample of 66 Islamic banks over the period 2001‐2006 using Beidleman's and Eckel's coefficients. Data are obtained from the Bankscope database. To test the use of LLPs to smooth Islamic banks results, a regression model was developed and tested.
Findings
The results provide evidence on an extensive use of income smoothing by Islamic banks. More than 75 per cent of the examined banks have a determination coefficient between 0.5 and 1 and 44 per cent have a variation coefficient less than 0.5. However, income smoothing is not achieved through LLPs. The variable earnings before taxes and provisions are not significant in all model specifications. The paper advances that these smoothed incomes are derived rather by the use of profit equalization reserve (PER) and investment risk reserve (IRR). The finding is contradictory to the widespread view stating that those mechanisms are designed to stabilize rewards attributed to investment account holders.
Research limitations/implications
The non‐disclosure of detailed information on PER and IRR prevented the empirical testing of the assertion on the use of these discretionary items to smooth Islamic banks' incomes.
Originality/value
Unlike previous studies which implicitly assume that Islamic banks intentionally use accounting techniques to disclose smoothed results, this paper pioneers the study on detecting income smoothing practice by such institutions. Second, it explores the use of LLPs for earnings management purposes in the context of a fast growing industry where Islamic assets have grown on average by 30 per cent per year over the period 2002‐2007. Third, it is the first paper to give some evidence on the use of PER and IRR as income smoothing devices. Finally, the paper covers a larger number of Islamic banks and from various countries.
Details
Keywords
Abdelkader Boudriga, Neila Boulila Taktak and Sana Jellouli
The purpose of this paper is to empirically analyse the cross‐countries determinants of nonperforming loans (NPLs), the potential impact of supervisory devices, and institutional…
Abstract
Purpose
The purpose of this paper is to empirically analyse the cross‐countries determinants of nonperforming loans (NPLs), the potential impact of supervisory devices, and institutional environment on credit risk exposure.
Design/methodology/approach
The paper employs aggregate banking, financial, economic, and legal environment data for a panel of 59 countries over the period 2002‐2006. It develops a comprehensive model to explain differences in the level of NPLs between countries. To assess the role of regulatory supervision on credit risk, the paper uses several interactions between institutional features and regulatory devices.
Findings
The empirical results indicate that higher capital adequacy ratio (CAR) and prudent provisioning policy seems to reduce the level of problem loans. The paper also reports a desirable impact of private ownership, foreign participation, and bank concentration. However, the findings do not support the view that market discipline leads to better economic outcomes. All regulatory devices do not significantly reduce problem loans for countries with weak institutions, corrupt environment, and little democracy. Finally, the paper shows that the effective way to reduce bad loans is through strengthening the legal system and increasing transparency and democracy, rather than focusing on regulatory and supervisory issues.
Practical implications
First, higher CARs results in less credit exposures. Second, international regulators should continue their efforts to enhance financial development. The results suggest that foreign participation plays an important role in reducing credit exposure of financial institutions. However, in developed countries, foreign entry led to more problem loans. Finally, to reduce credit risk exposure in countries with weak institutions, the effective way to do it is through enhancing the legal system, strengthening institutions, and increasing transparency and democracy.
Originality/value
The paper contributes to the literature on banking regulation and supervision. It examines aggregated data which best reflect the level of NPL of the banks in a country as opposed to individual data included in databases that suffer from the problem of representativeness. It considers the impact of regulatory variables after controlling for bank industry factors that alter primarily problem loans. Finally, the paper examines the effectiveness of regulation through the inclusion of institutional factors.