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Influence of Supervision and Regulation on Bank Financial Reporting

This research explores the impact of supervision and regulation on the conservatism of bank financial reporting across different countries. It investigates institutional factors that contribute to improving bank incentives for conservative reporting and strengthening banking governance. The findings suggest that powerful regulatory supervisors, private sector monitoring, and direct or indirect government policies play significant roles in shaping the conservatism of bank financial reporting.

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Influence of Supervision and Regulation on Bank Financial Reporting

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  1. The Influence of Supervision and Regulation on the Conservatism of Bank Financial Reporting: International Evidence Yuanchen Chang National Chengchi University Hsiangping Tsai National Chengchi University K.C. John Wei Hong Kong University of Science and Technology 200612

  2. Introduction • Scandals for financial institutions • Fannie Mae, 2004; Fortress Re, 2004; Livedoor, 2006 • Conservative financial reporting strengthens CG • Watts (2003a, 2003b); Bushman et al. (2005) • Institutional factors & management incentives • Law origin: Ball et al. (2000) • Insider communication and Political intervention: Ball et al. (2003), Bushman and Piotroski (2005) • Listing status: Ball and Shivakumar (2005), Nichols et al. (2005)

  3. Effects of regulation and supervision practices • Powerful regulatory supervisors vs. empowering private sector monitoring • Barth et al. (2004), Beck et al. (2005) • Supervisory monitoring • Berger and Davies (1998), DeYoung et al. (2001), Gunther and Moore (2003) • Private sector discipline • Martinez Soledad and Schmukler (2001), Demirgüç and Huizinga (2004), Caprio and Honohan (2004), Flannery (1998)

  4. Research questions • Are banks around the world conservative in their financial reporting? • What institutional factors contribute to improve bank incentive to be conservative in financial reporting and strengthen banking governance? • Direct government supervision and regulation policies • Indirect government policies that encourage private sector monitoring

  5. Q1: Are banks around the world conservative in their financial reporting? Loan loss reporting Earnings changes (-) (+) (+) (-) Methodology

  6. Q2: What institutional factors contribute to improve bank incentive to be conservative in financial reporting? • PRI monitor related index • PUB (-) • PRIIDX: (-) • DEPOINSUR, BKDISCL • AUDIT, LBKRATE • SUP related index • CAR (?) • SUPPWR: (-) • CORRPWR, RESTRPWR, INSLVNPWR Methodology

  7. Data and sample selection • Data sources • BANKSCOPE: bank level data • Commercial law origin: La Porta et al. (2002) • Bank supervision and regulation variables: • the bank regulation and supervision database (the 2003 edition) supplied by the World Bank • Sample countries • Step1: La Porta et al. (2002) → 92 countries • Step2: control for the availability of bank regulation & accounting information →48 countries

  8. Financial reporting conservatism by public and private banks across 48 countries: pooled results

  9. Findings and conclusions (1) • Using pooled data from 48 countries, we show that banks, especially public banks, are conservative in their financial reporting • A greater tendency of earnings reversal for negative earnings changes than for positive earnings changes • Incorporate more loan loss provisions • when their operating cash flows decrease, or • When their problem loans increase • Charge off more problem loans when their loan loss provisions increase.

  10. Effects of governance mechanisms on conservative reporting of earnings changes

  11. Effects of governance mechanisms on conservative reporting of loan losses

  12. Findings and conclusions (2) • The cross-country comparison shows • Bank conservatism in financial reporting is more pronounced in countries where • Supervisors are more empowered to apply adequate actions on banks • Private sector players are more encouraged to monitor banks

  13. Findings and conclusions (3) • Bank supervision and regulation practices, rather than legal origins, are more important in explaining international differences in the conservatism of financial reporting among banks.

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