In this paper we test for the impact of the regulatory environment on a bank’s discretionary provisioning practices. We develop a model that structures the dynamics of the provision policy for the two classes of provisions: generic provisions and specific provisions. The model is tested using a comprehensive database of all financial institutions operating in Portugal for 1990-2000. This unique dataset comprises banks subject to the Portuguese rules as well as bank subsidiaries subject to their home-country regulation and we were able to identify distinct behaviours between them. Our results show the importance of handling the two types of provisions separately. They support the hypothesis that banks have a discretionary behaviour in setting up their provisions, and find evidence of income-smoothing and capital management. We also find that the regulatory regime impacts on discretionary provisioning policies because banks when forced to increase one type of provision react by reducing the discretionary component of the other, a finding we designated as a substitution effect.
|Journal||Journal of Money, Investment and Banking|
|Publication status||Published - 1 Jan 2009|