To Use or Not to Use - an Empirical Study of Visible Reserves in Bank Accounting in the Light of Regulatory Requirements and Informational Asymmetries
Year: 2008
Type: preprint
Abstract: Banks are considered to be rather opaque institutions compared to many other industries. Existing bank-specific accounting rules certainly add to this image to a great extent. An emerging lack of transparency in banks' financial reporting is justified by the particular kinds and levels of risk banks are exposed to.
To cover these risks, on the one hand regulatory bodies impose certain restrictions on the amount of risky assets held by banks in relation to their capital resources. On the other hand, legal bodies quite generally allow the building of reserves and loss provisions within the financial statements of banks.
The German Commercial Code ('HGB') contains two unique, but very different instruments permitting banks to build reserves. Firstly, para. 340f HGB allows for deliberately undervaluing specified financial assets within certain limits. This is often referred to as creating hidden reserves (henceforth called '340f-reserves'). Secondly, a bank may increase its visible 'reserves for general banking risks' in accordance to para. 340g HGB (henceforth called 'GBR-reserves'). Banks may be using these two types of reserves for very different reasons. GBR-reserves are the main focus of this paper.
340f-reserves certainly contribute to the perceived opaqueness of banks as they undermine the pre- and post-decision information functions of accounting regulations. To some extent, this also holds for GBR-reserves. They are visible, but it is not obvious whether they represent existing risks or if they were just being built as part of the banks' earnings management. Furthermore, they may also have been built for enhancing capital endowment or internal financing purposes.
This paper empirically investigates which banks are using GBR-reserves and for what reason. We will analyze the development of this balance sheet item on the bank-level over time. Regulatory constraints as well as concepts such as the Pecking Order Theory focussing on information asymmetries help to provide explanations and enable us to identify key factors responsible for our findings.
Our analysis is based on an unbalanced panel of German banks including 22,080 observations. We see (1) the use of GBR-reserves increasing over time. Furthermore, GBR-reserves are primarily used by (2) large banks, (3) public banks, (4) banks reporting according to international financial reporting standards in addition to HGB, and (5) banks with comparatively low regulatory capital endowment. Moreover, our results show that (6) predominantly banks which are not thrifts and cooperatives are making use of GBR-reserves, and (7) that GBR-reserves are used for earnings management.
Source: SSRN Electronic Journal
Institutions: University of Münster, University of Rostock
Language: English
Subfield: Accounting
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W2734730820