Bank Earnings Smoothing, Audit Quality and Procyclicality in Africa: The Case of Loan Loss Provisions

This paper empirically examine whether the way African banks use loan loss provisions to smooth earnings is influenced by capital market motivations and the type of auditor after controlling for non-discretionary determinants of loan loss provisions and fluctuations in the business cycle. The findings support the income smoothing hypothesis and indicate that (i) African banks use loan loss provisions to smooth reported earnings; (ii) listed African banks use loan loss provisions to smooth earnings to a greater extent than non-listed African banks possibly for capital market reasons; (iii) income smoothing via loan loss provisions is not reduced among African banks with Big 4 auditor; and (iv) bank provisioning in Africa is procyclical with fluctuations in the business cycle. The findings have three implications. One, listed African banks smooth income because they are more visible to investors and investors do not view stock price fluctuation as a good signal. Securities market regulators in African countries should enforce strict disclosure rules that reduce earnings smoothing practices in order to improve the transparency of banks’ reported earnings in the region. Two, the presence of Big 4 auditor did not improve the informativeness of loan loss provisions estimates among African banks. Three, the evidence for procyclical provisioning suggest the need for dynamic loan loss provisioning system in Africa.