DO BANKS GAME ON DYNAMIC PROVISIONING?

Abstract

Reducing credit procyclicality represents one of the key challenges on the regulatory agenda to reform the financial system architecture. Some early experiences may provide some insights on how countercyclical regulations may be effective. The Spanish dynamic provisions scheme implemented in 2000 is one of the main reference points in this context. We analyze the effects of dynamic provisions on managerial accounting discretion and ex-ante risk-taking behavior by banks. We empirically examine a sample of Spanish banks using quarterly information from 1995Q1 to 2013Q4. Our findings suggest that the counter-cyclicality of provisions has been reduced over time, as it has also been the case of managerial discretion (income smoothing and profit signaling). However, the results suggest that banks game on dynamic provisions by taking an ex-ante riskier behavior once the dynamic provisioning scheme is adopted.