Capital (and Earnings) Incentives for Loan Loss Provisions in Brazil: evidence from a crisis-buffering regulatory intervention

Produced by: 
Banco Central do Brasil
Available from: 
May 2018
Paper author(s): 
Ricardo Schechtman
Tony Takeda
Topic: 
Financial Economics
Macroeconomics - Economic growth - Monetary Policy
Year: 
2018

In order to provide higher incentives for loan loss provisions (LLP) of Brazilian banks when bad times were looming ahead, the discretionary excess in loan loss reserves was recognized temporarily as regulatory capital, in a sort of countercyclical policy. This study explores this regulatory change to investigate the capital management incentives of LLP of Brazilian banks. Results show that banks with less regulatory capital increased relatively more discretionary LLP during the regulatory change but not outside it, suggesting that capital management through discretionary LLP was relevant only during that period. On the other hand, banks with less earnings made less discretionary LLP throughout the sample period, suggesting earnings smoothing was relevant during the whole period. Results are robust to different realized and forward loan loss controls, different measures of capital before endogenous items, time-varying capital targets, and to the recognition of possible heterogeneous effects of the global financial crisis across Brazilian banks.

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