IDEAS home Printed from https://ideas.repec.org/a/bla/abacus/v40y2004i3p321-341.html
   My bibliography  Save this article

A Methodology for Calculating the Allowance for Loan Losses in Commercial Banks

Author

Listed:
  • Robert P. Gray
  • Frank L. Clarke

Abstract

Severe disturbances in the financial markets in many countries during the 1980s and 1990s caused many stakeholders to examine whether commercial banks had adequate reserves for future loan losses. In the United States, bank regulators considered an adequate Allowance for Loan Losses a ‘safety and soundness’ issue while the SEC became increasingly concerned over the possibility of banks using the Allowance as a method to ‘manage earnings’. Both regulators demanded more rigorous calculations from banks to support their accounting entries. Also the FASB and the IASB have expressed concerns about a lack of harmonization and convergence in standards. An analysis of measurement standards in the United States, Canada, Japan, the United Kingdom and Australia, as well as by the Basel Committee on Banking Supervision and the IASB, reveals the partially conflicting goals for the Allowance: (a) promote harmonization (IASB), (b) increase transparency (SEC), (c) promote safety and soundness (bank regulators) and (d) maintain reasonable flexibility in recognition of the subjective aspects in determining an appropriate Allowance (bankers). The article offers a methodology which an individual bank may utilize to reconcile the conflicting goals of all interested parties.

Suggested Citation

  • Robert P. Gray & Frank L. Clarke, 2004. "A Methodology for Calculating the Allowance for Loan Losses in Commercial Banks," Abacus, Accounting Foundation, University of Sydney, vol. 40(3), pages 321-341, October.
    • Handle: RePEc:bla:abacus:v:40:y:2004:i:3:p:321-341
    DOI: 10.1111/j.1467-6281.2004.00161.x
    as

    Download full text from publisher

    File URL: https://doi.org/10.1111/j.1467-6281.2004.00161.x
    Download Restriction: no
    File URL: https://libkey.io/10.1111/j.1467-6281.2004.00161.x?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Claudio Borio & Craig Furfine & Philip Lowe, 2001. "Procyclicality of the financial system and financial stability: issues and policy options," BIS Papers chapters, in: Bank for International Settlements (ed.), Marrying the macro- and micro-prudential dimensions of financial stability, volume 1, pages 1-57, Bank for International Settlements.
    2. Kim, Daesik & Santomero, Anthony M., 1993. "Forecasting required loan loss reserves," Journal of Economics and Business, Elsevier, vol. 45(3-4), pages 315-329.
    3. Chevalier, Judith A & Scharfstein, David S, 1996. "Capital-Market Imperfections and Countercyclical Markups: Theory and Evidence," American Economic Review, American Economic Association, vol. 86(4), pages 703-725, September.
    4. Lucas, Andre & Klaassen, Pieter & Spreij, Peter & Straetmans, Stefan, 2001. "An analytic approach to credit risk of large corporate bond and loan portfolios," Journal of Banking & Finance, Elsevier, vol. 25(9), pages 1635-1664, September.
    5. Timothy W. Koch & Larry D. Wall, 2000. "Bank loan-loss accounting: a review of theoretical and empirical evidence," Economic Review, Federal Reserve Bank of Atlanta, vol. 85(Q2), pages 1-20.
    6. Altman, Edward I. & Saunders, Anthony, 1997. "Credit risk measurement: Developments over the last 20 years," Journal of Banking & Finance, Elsevier, vol. 21(11-12), pages 1721-1742, December.
    7. Burgstahler, David & Dichev, Ilia, 1997. "Earnings management to avoid earnings decreases and losses," Journal of Accounting and Economics, Elsevier, vol. 24(1), pages 99-126, December.
    8. Degeorge, Francois & Patel, Jayendu & Zeckhauser, Richard, 1999. "Earnings Management to Exceed Thresholds," The Journal of Business, University of Chicago Press, vol. 72(1), pages 1-33, January.
    9. DeAngelo, Harry & DeAngelo, Linda & Skinner, Douglas J., 1996. "Reversal of fortune Dividend signaling and the disappearance of sustained earnings growth," Journal of Financial Economics, Elsevier, vol. 40(3), pages 341-371, March.
    10. Ahmed, Anwer S. & Takeda, Carolyn & Thomas, Shawn, 1999. "Bank loan loss provisions: a reexamination of capital management, earnings management and signaling effects," Journal of Accounting and Economics, Elsevier, vol. 28(1), pages 1-25, November.
    11. Kane, Edward J, 1996. "De Jure Interstate Banking: Why Only Now?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(2), pages 141-161, May.
    12. Timothy W. Koch & Larry D. Wall, 2000. "The use of accruals to manage reported earnings: theory and evidence," FRB Atlanta Working Paper 2000-23, Federal Reserve Bank of Atlanta.
    13. Robert P. Gray, 2003. "Research Note: Revisiting Fair Value Accounting––Measuring Commercial Banks’ Liabilities," Abacus, Accounting Foundation, University of Sydney, vol. 39(2), pages 250-261, June.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Mora, Araceli, 2018. "The role of Politics and Economics in the International Financial Reporting Standards (IFRS) Adoption/La influencia de la política y la economía en la adopción de las Normas Internacionales de Informa," Estudios de Economia Aplicada, Estudios de Economia Aplicada, vol. 36, pages 407-428, Mayo.
    2. José Alves Dantas & Otávio Ribeiro de Medeiros & Paulo Roberto Barbosa Lustosa, 2013. "The Role of economic variables and credit portfolio attributes for estimating discretionary loan loss provisions in Brazilian banks," Brazilian Business Review, Fucape Business School, vol. 10(4), pages 65-90, October.
    3. García Osma, Beatriz & Mora, Araceli & Porcuna-Enguix, Luis, 2019. "Prudential supervisors’ independence and income smoothing in European banks," Journal of Banking & Finance, Elsevier, vol. 102(C), pages 156-176.
    4. A. M. B. Araujo & P. R. B. Lustosa, 2019. "The cyclicality of loan loss provisions under three different accounting models: the United Kingdom, Spain, and Brazil," Papers 1907.07491, arXiv.org.
    5. Di Fabio, Costanza & Ramassa, Paola & Quagli, Alberto, 2021. "Income smoothing in European banks: The contrasting effects of monitoring mechanisms," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 43(C).

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Shaharudin, Roselee, 2004. "A Review on Accounts Manipulation Via Loan Loss Provisions to Manage Regulatory Capital and Earnings Along Business Cycle," Jurnal Ekonomi Malaysia, Faculty of Economics and Business, Universiti Kebangsaan Malaysia, vol. 38, pages 99-123.
    2. Małgorzata Olszak & Mateusz Pipień & Iwona Kowalska & Sylwia Roszkowska, 2017. "What Drives Heterogeneity of Cyclicality of Loan-Loss Provisions in the EU?," Journal of Financial Services Research, Springer;Western Finance Association, vol. 51(1), pages 55-96, February.
    3. Malgorzata Olszak & Mateusz Pipien & Sylwia Roszkowska & Iwona Kowalska, 2014. "The effects of capital on bank lending in large EU banks – the role of procyclicality, income smoothing, regulations and supervision," Faculty of Management Working Paper Series 52014, University of Warsaw, Faculty of Management.
    4. Mary E. Barth & Javier Gomez-Biscarri & Ron Kasznik & Germán López-Espinosa, 2017. "Bank earnings and regulatory capital management using available for sale securities," Review of Accounting Studies, Springer, vol. 22(4), pages 1761-1792, December.
    5. Olszak, Małgorzata & Pipień, Mateusz & Kowalska, Iwona & Roszkowska, Sylwia, 2014. "What drives heterogeneity of loan loss provisions’ procyclicality in the EU?," MPRA Paper 56834, University Library of Munich, Germany.
    6. Zainuldin, Mohd Haniff & Lui, Tze Kiat, 2020. "Earnings management in financial institutions: A comparative study of Islamic banks and conventional banks in emerging markets," Pacific-Basin Finance Journal, Elsevier, vol. 62(C).
    7. Laeven, Luc & Majnoni, Giovanni, 2003. "Loan loss provisioning and economic slowdowns: too much, too late?," Journal of Financial Intermediation, Elsevier, vol. 12(2), pages 178-197, April.
    8. Balboa, Marina & López-Espinosa, Germán & Rubia, Antonio, 2013. "Nonlinear dynamics in discretionary accruals: An analysis of bank loan-loss provisions," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 5186-5207.
    9. Tuba Toksoz, 2022. "An Examination of Other‐than‐temporary Impairments: Evidence from FSP FAS 115‐2 and FAS 124‐2," Abacus, Accounting Foundation, University of Sydney, vol. 58(2), pages 262-299, June.
    10. Ignacio Ferrero & Alejo José G. Sison, 2012. "A Survey on Virtue in Business and Management (1980-2011)," Faculty Working Papers 06/12, School of Economics and Business Administration, University of Navarra.
    11. Yves Mard, 2003. "Performance Comptable Et Gestion Des Resultats," Post-Print halshs-00582798, HAL.
    12. Emrah Arbak, 2017. "Identifying the provisioning policies of Belgian banks," Working Paper Research 326, National Bank of Belgium.
    13. Ozili, Peterson K, 2017. "Bank Loan Loss Provisions Research: A Review," MPRA Paper 76495, University Library of Munich, Germany.
    14. Cavallo, Michele & Majnoni, Giovanni, 2001. "Do Banks provision for bad loans in good times? empirical evidence and policy implications," Policy Research Working Paper Series 2619, The World Bank.
    15. Bornemann, Sven & Kick, Thomas & Memmel, Christoph & Pfingsten, Andreas, 2012. "Are banks using hidden reserves to beat earnings benchmarks? Evidence from Germany," Journal of Banking & Finance, Elsevier, vol. 36(8), pages 2403-2415.
    16. Gilliam, Thomas A. & Heflin, Frank & Paterson, Jeffrey S., 2015. "Evidence that the zero-earnings discontinuity has disappeared," Journal of Accounting and Economics, Elsevier, vol. 60(1), pages 117-132.
    17. Ozili, Peterson K & Outa, Erick R, 2018. "Bank Earnings Smoothing During Mandatory IFRS adoption in Nigeria," MPRA Paper 89690, University Library of Munich, Germany.
    18. Dung Viet Tran & M. Kabir Hassan & Reza Houston, 2020. "Discretionary loan loss provision behavior in the US banking industry," Review of Quantitative Finance and Accounting, Springer, vol. 55(2), pages 605-645, August.
    19. Małgorzata Olszak & Iwona Kowalska & Patrycja Chodnicka-Jaworska & Filip Świtała, 2020. "Do cyclicality of loan-loss provisions and income smoothing matter for the capital crunch – the case of commercial banks in Poland," Bank i Kredyt, Narodowy Bank Polski, vol. 51(4), pages 383-436.
    20. Meng-Fen Hsieh & Chung-Hua Shen, 2011. "Business cycles and bank regulations - what happens to bank provisioning? A more comprehensive look at 49 countries," Applied Economics, Taylor & Francis Journals, vol. 43(21), pages 2811-2822.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bla:abacus:v:40:y:2004:i:3:p:321-341. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: http://www.blackwellpublishing.com/journal.asp?ref=0001-3072 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.