Bank business models, failure risk and earnings opacity: A short- versus long-term perspective

Despite the ongoing bank regulatory reforms, relatively little research attention has been given to the effects of bank business models and opacity of bank balance sheet structure which may hinder regulation and market discipline. In this study, we explore the effects of business model strategies on banks' earnings opacity in the UK banking sector. Distinguishing between the short-term (within) and long-term (between) effects, our findings suggest that retail-oriented business models reduce the likelihood of earnings management practices in the short term but not over the long term. In contrast, wholesale-oriented business models increase the probability of earnings manipulation both in the short and long term. While bank business models characterised by a greater degree of functional diversification tend to lower earnings manipulation in the short term, the long-term incentives cannot be mitigated. Our findings also demonstrate that low failure risk (or greater solvency) represents an important channel in mitigating the effects of business models on earnings management practices both in the short and long term. Our results are robust to alternative proxies for earnings management and failure risk, and the use of alternative methods.