Do Bank Regulations Influence Banks’ Financial Reporting Quality?

• In Event: Financial Institutions and the Financial Crisis

Abstract

This paper examines whether bank regulations influence banks’ financial reporting behavior? We evaluate this question in a cross country setting covering 2005 to 2011 time period. Specifically, we distinguish and scrutinize two types of regulations: regulatory requirements related to the external audit function and regulations related to supervisory oversight of the external auditors. We find stringent requirements on the external auditing function improves financial reporting quality as measured by income smoothing using loan-loss provisions, abnormal loan-loss provisions; association between loan-loss provisions and actual loans written off; earnings predictability, and the ability to manage earnings to meet or beat benchmarks. We find this relation is robust to the inclusion of factors related to the quality of other country level institutions. In contrast, we fail to detect any improvement in bank’s financial reporting quality related to stringent oversight of external auditors. Our analysis highlights the importance of crafting appropriate regulations because they shape the quality of the resulting financial statements.

Authors

• Inder K. Khurana, University of Missouri-Columbia

• Raynolde Pereira, University of Missouri-Columbia

• Rong Zhong, University of Missouri-Columbia