The quality and transparency of banks’ financial reporting became a central issue following the global financial crisis and the introduction of Basel III. Unlike non-financial firms, banks have greater discretion in estimating loan loss provisions (LLPs), creating opportunities to influence reported earnings and regulatory capital. Prior studies suggest that LLPs may be used to smooth income, satisfy capital requirements, or signal future performance (Ahmed et al., 1999; Greenawalt & Sinkey, 1988; Beatty et al., 2002). At the same time, the increased emphasis on prudential regulation and financial reporting quality has intensified the debate on whether such discretion improves financial stability or reduces the transparency of financial statements (Fonseca & Gonzalez, 2008; Curcio & Hasan, 2015).
This study contributes to this discussion by examining earnings management in European listed commercial banks during the post-crisis Basel III period. The paper investigates whether the incentives created by profitability and regulatory constraints are associated with the discretionary use of LLPs. The empirical evidence indicates that LLPs remain an important mechanism through which banks influence reported earnings, which supports the income-smoothing argument widely documented in the banking literature (Ahmed et al., 1999; Kanagaretnam et al., 2004). Furthermore, the findings suggest that banks that operate with relatively lower net interest margins appear more likely to understate provisions, thereby presenting stronger reported profitability. By contrast, evidence that banks manipulate LLPs primarily to satisfy capital adequacy requirements is comparatively limited, indicating that Basel III may have reduced the scope for regulatory capital management.
The study highlights the importance of considering profitability, prudential regulation, and accounting discretion jointly when evaluating the quality of banks’ financial statements. The findings reinforce concerns that accounting flexibility in loan loss provisioning can affect the reliability of reported earnings and investors’ assessment of bank risk (Hutton et al., 2009; Jin & Myers, 2006). Overall, the paper contributes to the literature by emphasizing the role of net interest margin as an additional determinant of discretionary provisioning and suggests that regulators, auditors, and investors should evaluate LLPs together with broader indicators of bank performance.

JEL Classification
G21; G28; M41

References
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