Finance Research Letters xxx (xxxx) xxx

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Finance Research Letters

journal homepage: www.elsevier.com/locate/frl

The impact of banking regulations and accounting standards on

estimating discretionary loan loss provisions
Ashish Pandey a, 1, *, Abhinava Tripathi b, 2, Kousik Guhathakurta c, 3
a
Indian Institute of Management, Prabandh Nagar, Lucknow, India
b
Indian Institute of Technology, Roorkee, India
c
Indian Institute of Management, Prabandh Shikhar, Indore, India

A R T I C L E I N F O A B S T R A C T

JEL classification: Loan loss provisions (LLP) are relatively large accruals for commercial banks. The discretionary
G21 nature of LLP makes them particularly useful in examining the impact of regulations on mana­
G28 gerial behaviour. The accounting standards in emerging countries are often rule-based instead of
M41
the principle-based approach adopted in developed countries. We propose and compare a new
E32
specification incorporating the rule-based approach with nine widely employed LLP specifications
Keywords:
used in the literature. We show empirically, employing a range of model selection criteria, that
Loan loss provision
our proposed specification is more suitable for understanding the information content of LLP in
Discretionary provision
Nonperforming asset emerging countries. In this study, all the specifications are compared and examined using data
Accruals from India, a large and important emerging economy.
Managerial behaviour
Incurred-loss approach

1. Introduction

Loan loss provisions (LLP) are relatively large accruals for commercial banks (Ahmed et al., 1999), and therefore, have a significant
impact on banks’ earnings and regulatory capital. Moreover, LLP are one of the leading accounting disclosure items that offer a
substantial scope of discretion to managers (Moyer, 1990). The discretionary nature of LLP makes them particularly useful in
examining the impact of regulations on managerial behaviour (Kim and Kross, 1998). The main objective of LLP is to modify the banks’
loan loss reserves to reflect the expected future losses in the banks’ loan portfolio. However, prior evidence suggests that managers
employ LLP to (a) manage earnings (b) manage regulatory capital, and (c) as a signal to communicate their private information to
investors about future prospects (Bushman and Williams, 2012; Elliott et al., 1991; Moyer, 1990; Scholes et al., 1990). Several models
have been proposed in the banking literature to estimate the expected LLP and identify the discretionary component. These models
include Wahlen (1994), Beatty et al. (1995), Beaver and Engel (1996), Kim and Kross (1998), Ahmed et al. (1999), Liu and Ryan
(2006), Kanagaretnam et al. (2010), Bushman and Williams (2012), Beck and Narayanmoorthy (2013), Bouvatier et al. (2014),

We are grateful to the Editor, Professor Jonathan Batten, and an anonymous reviewer for very helpful comments.
* Corresponding author.
E-mail addresses: ashish.pandey@iiml.ac.in (A. Pandey), abhinava.tripathi@ms.iitr.ac.in (A. Tripathi), kousikg@iimidr.ac.in (K. Guhathakurta).
1
Assistant Professor in the Finance and Accounting area at IIM, Lucknow.
2
Assistant Professor in the Management Studies area at IIT, Roorkee.
3
Associate Professor in the Finance and Accounting area at IIM, Indore.

https://doi.org/10.1016/j.frl.2021.102068
Received 18 January 2021; Received in revised form 18 March 2021; Accepted 11 April 2021
Available online 20 April 2021
1544-6123/© 2021 Elsevier Inc. All rights reserved.

Please cite this article as: Ashish Pandey, Finance Research Letters, https://doi.org/10.1016/j.frl.2021.102068
A. Pandey et al. Finance Research Letters xxx (xxxx) xxx

Andries et al. (2017), and Curcio et al. (2017). Few authors have specifically studied the impact of regulatory guidelines on allowance
estimation. Ahmed et al. (1999) identify the relationship between loan loss provisions and regulatory capital in response to changes in
regulations. They argue that a change in regulations “substantially alters banks’ incentives to manage capital and earnings via loan loss
provisions”. Beck and Narayanmoorthy (2013) analyse the conflicting role of guidance offered by the banking regulator and capital
markets regulator. They suggest that banking regulators take actions to ensure adequate allowance in unstable environments by
issuing new regulatory guidance. Ludwig (2009) also discusses this conflict in the context of overprovisioning by SunTrust Bank in the
United States.
We argue that the relationship between LLP and its determinants is influenced by the regulatory guidance and accounting standards
used in the country. Emerging countries have substantially different standards for accounting of loan losses when compared to
Financial Accounting Standards (FAS) 114, FAS 5, and International Accounting Standards (IAS) 39 used in the developed countries. In
particular, the loan loss provisioning in emerging countries is often rule-based instead of principle-based, and is driven by the
“incurred-loss” approach leaving limited avenues for managerial discretion. Hence, the results on the suitability of LLP models from
developed markets cannot be generalized to the emerging countries.4 This motivates us to explore an LLP specification that can help
regulators, policymakers, standard setters, and auditors in examining the information content of LLP for emerging countries that use a
rule-based approach. To make our case, we take India, an important emerging market, as an example. The Indian banking sector is
dominated by public sector banks (PSBs) that account for nearly 70% of the banking activity in the country. These banks are majority-
owned by the government. The dual role adopted by the government of being a regulator and a controlling shareholder offers a unique
context to our study.
This paper makes two important contributions to the banking literature. First, we offer evidence on the role of accounting standards
and regulatory mechanisms in influencing discretionary managerial behaviour. Second, the paper proposes a novel specification for
estimation of discretionary LLP that is more appropriate in the context of emerging markets that use rule-based approach. The rest of
the article is structured as follows. Section 2 discusses the background and motivation. Section 3 proposes the new specification and
Section 4 provides data and methodology. Section 5 provides estimation results and comparison, and Section 6 concludes.

2. Background and motivation

We argue that the accounting policies for loan loss recognition in developed countries are significantly different from those in
emerging countries (Angklomkliew et al., 2012; Ozili and Outa, 2017; Packer and Zhu, 2012). For example, FAS 5 in the United States
is used to estimate credit losses on a pool of homogeneous loans, while FAS 114 is used to estimate credit losses for heterogeneous loans
(Baskin et al., 2016). The above standards are principle-based, and bank management has significant discretion available to account
for credit losses (Danisman et al., 2021; Krüger et al., 2018; López-Espinosa et al., 2020). The calculation of credit loss for general
reserve, established under FAS 5, involves three discretionary actions by the management (Board of Governors of the Federal Reserve
System, 2006; Satwah, 2014). The first action is the acknowledgement that a loan loss is ‘probable’ at the time of issuing financial
statements. There is no explicit definition offered in the standard to quantify the probability that a loan loss is indeed probable. The
second discretionary action is the segmentation of homogeneous loan pools. The bank manager has discretion available in deciding the
type of pool for the impaired loan. The historical loss experience of the segment selected by the manager is applied to arrive at an
estimated provision for the loan. Third, the management can make several adjustments based on the assessment of loan quality and the
macroeconomic environment.5 The accounting for LLP in the non-accrual category under FAS 114 allows similar discretion to the bank
management to select the loss estimation methodology. The bank management is permitted to select one of the three approaches for
incurred loss estimation. These three approaches are based on (a) the fair market value of collateral, (b) the present value of future cash
flows from the loan, and (c) the current fair market value of the loan. Each of these approaches has an additional element of discretion
involved. A similar approach was adopted by IAS 39 used in European countries till 2018 (Ernst and Young, 2018). The evidence that
an asset is impaired under IAS 39 standard included the presence of observable data for multiple loss events that suggest a measurable
decrease in the estimated future cash flows.6 For individual assets, the quantification of impairment losses is based on management’s
assessment of the present value of future cash flows discounted at the loan’s original effective interest rate. The quantification of
impairment losses on a pool of assets is based on the historical experience similar to FAS 114.
In contrast, the prudential norms on income recognition, asset classification, and provisioning (IRACP) issued in India by the
banking regulator, Reserve Bank of India (RBI), leave little discretion to the bank management (Chipalkatti and Rishi, 2007; Maha­
patra, 2012; Misra et al., 2020). There is an explicit definition for nonperforming assets that brings any asset which has remained past
due for 90 days or more under the ambit of provisioning policy. Loans are further required to be classified as Sub-standard Assets,
Doubtful Assets, and Loss Assets. There is a prescribed matrix under IRACP where provisioning as a percentage of the outstanding loan

4
Additional differences in emerging markets from their developed counterparts exist on various aspects related to banking such as the strength of
regulatory institutions and regulatory framework, cost of discretionary behaviour, financial reforms and liberalization, issues related to corporate
governance, etc. (Bekaert et al., 2007; Prasad, 2010).
5
For example, these adjustments can be made for changes in lending policy over time, changes in economic and business conditions, trends in
volume and terms of loans, effects of any changes in risk selection and underwriting standards, and the experience, ability, and depth of lending
management amongst others.
6
For example, these loss events may include the obligor’s financial difficulty, a default in interest or principal payments, restructuring of loan
terms, the probability that a borrower will enter in bankruptcy proceedings, or other financial reorganization.

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A. Pandey et al. Finance Research Letters xxx (xxxx) xxx

amount is defined for each subcategory of the loan. The provision for standard assets is also rule-based at 25 basis points for all the
unimpaired assets. Once a borrower has defaulted on a payment, the bank has little discretion left in the categorization of such assets
(Bawa et al., 2019). The subsequent provisioning requirements have an algorithmic characteristic. The complete guideline for IRACP is
available at RBI website.7 We deem the guidelines issued by RBI as extremely prescriptive (Acharya, 2017). Further differences in
emerging markets from their developed counterparts exist on various banking features such as the strength of regulatory institutions
and regulatory framework, cost of discretionary behaviour, financial reforms and liberalization, issues related to corporate gover­
nance, etc. (Bekaert et al., 2003; Prasad, 2010). Each of the above features has the potential to affect the discretionary behaviour
exercised by bank management. We, therefore, hypothesize that there may be limited applicability of principle-based LLP models
proposed in the context of the developed countries. The LLP models based on the principle-based approach should be reevaluated in
the context of an emerging country and compared with the alternative LLP model incorporating a rule-based approach. In the interest
of clarity, we highlight that we do not deem the guidelines prescribed by RBI as superior to those prescribed under Financial Ac­
counting Standards Board (FASB) or IAS standards. We believe that FASB and IAS standards offer more discretion with an intent to
better capture the actual expected losses. Our argument is limited to the observation that the differences in regulatory mechanism and
accounting standards between the developed countries and emerging countries also result in the differences in discretion available to
the bank management. The reduced discretion available in the context of emerging countries may necessitate a different model
specification to appropriately identify the discretionary component of the LLP (Restoy and Zamil, 2017).

3. Proposed model specification

Extant literature (Beatty et al., 1995; Moyer, 1990; Wahlen, 1994) suggests that there are two primary components of LLP. First, the
expected component that depends on the lagged default values of nonperforming assets and additions to performing assets. Second, the
unexpected component of LLP that comprises (a) management’s expectations of the current period and additional future loan losses,
and (b) a discretionary component. We use the guidelines suggested under IRACP as a starting point to develop the model. The loan
status (performing or nonperforming) has a bearing on the amount of provision. A higher amount of nonperforming assets will require
higher provisioning in the current period and the subsequent periods if the loan status does not improve. We include the total amount
of nonperforming assets (NPA) as the first variable in our model. We expect that the coefficient for NPA should be positive. The
charged-off loans in the current period increase the aggregate amount of provision to the extent that the provision was not made for the
entire carrying value of the loan. We include charged-off loans (CHO) as the second variable in our specification and hypothesize a
positive sign for its coefficient. Since the amount of provisioning increases with the time for which a loan has remained in the
nonperforming status under IRACP, we also include the change in nonperforming loans (DELNPA) and its two lags in our model. A
positive change in the current period NPA will indicate that additional loans have entered in the nonperforming category during the
reporting period. Similarly, an increase in the lagged terms of change in NPA will indicate that more loans have remained in the
nonperforming status for an extended period. Moreover, these lagged default values also affect the expected component of
non-discretionary charge-offs. We expect a positive coefficient for variables related to the change in nonperforming assets. An increase
in performing assets during the current period requires a dynamic provision of 25 basis points under IRACP. We include the change in
loans (DELLOAN) as the sixth variable in our model. A priori, the extant literature provides evidence of both positive and negative
relationships of LLP with DELLOAN (Beaver and Engel, 1996; Kanagaretnam et al., 2010; Kim and Kross, 1998). The positive rela­
tionship is explained by the expected-loss approach. It is argued that when LLP are forward-looking, an increase in loans bears ex­
pectations of higher NPAs in the future. In anticipation of these higher NPAs, a higher level of provisioning is expected when managers
are allowed to exercise discretion. In contrast, the incurred-loss approach proposes a negative relationship. If the NPAs in the prior
period are lower, banks will have lower LLP, and hence, more capacity to generate loans. A recessionary business environment will
result in additional NPAs and slow cure rate. We include the change in the gross domestic product (DGDP) in our specification to
capture the procyclical nature of the incurred-loss approach (Andries et al., 2017). Since more loans become NPA during a recession,
we expect a negative relationship between LLP and DGDP. Lastly, we include profit before taxes and provision (PBTP) in our speci­
fication to capture earnings management motivation. The managers have more discretion to report LLP during profitable periods
without worrying about regulatory capital adequacy, and therefore, we expect a positive sign for the coefficient. The specification of
our proposed model is as follows:
LLPi,t = β0 + β1 NPAi,t + β2 CHOi,t + β3 DELNPAi,t + β4 DELNPAi,t− 1 + β5 DELNPAi,t− 2
(1)
+ β6 DELLOANi,t + β7 DGDPt + β8 PBTPi,t + εi,t

4. Data description and methodology

4.1. Data description

The firm-level data for banks in India is provided by CMIE Prowess database. The macroeconomic indicators are availed from the
statistical handbook released by RBI. The study covers the period of 2009–2019. The provisioning requirement for standard assets was

7
Accessible from https://www.rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9908.

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A. Pandey et al. Finance Research Letters xxx (xxxx) xxx

first introduced in the year 2009. We select only those banks that form part of the major market indices on NSE and BSE8 (Nifty, BSE-
SENSEX, Bank-Nifty, BSE-Bankex). The listing exchange imposes additional requirements for reporting timeliness, audit quality, and
corporate governance. The final sample comprises 34 banks and 3419 bank-year observations.

4.2. Methodology

We compare our proposed model with the nine LLP specifications often used in the literature and identified by Beatty and Liao
(2014). Details of the LLP specifications and variable definitions are provided in Tables 1 and 2.
For the comparison of specifications, we employ five different model selection criteria [Adjusted-R2, F-statistic, Root mean square
error (RMSE), Akaike information criterion (AIC), and Bayesian Information Criterion (BIC)]. Our objective is to investigate whether

Table 1
LLP specifications.
S. No. Primary Motivation
1 Wahlen (1994, "Wahlen")
2 Collins et al. (1995, "Collins")
3 Beatty et al. (1995, "Beatty")
4 Beaver & Engel (1996, "Beaver")
5 Kim & Kross (1998, "Kim")
6 Liu & Ryan (2006, "Liu")
7 Kanagaretnam et al. (2010, "Kana")
8 Bushman & Williams (2012,
"Bushman")
9 Beck & Narayanamoorthy (2013,
"Beck")
Specification
∑5
LLPi,t = β0 + β1ALLWi,t + βnn=2 LOANCAT i,t-1+ β6NPAi,t + β7E[DELNPA]i,t + Ɛi,t
∑
where E[DELNPA]i,t = β0 + βn 4n=1 LOANCAT i,t-1 + β5DELNPAi,t-1
LLPi,t = β0 + β1ALLWi,t + β2NPAi,t + β3DELNPAi,t + Ɛi,t
LLPi,t = β0 + β1ALLWi,t + β2NPAi,t + Ɛi,t
LLPi,t = β0 + β1CHOi,t + β2DELLOANi,t + β3DELNPAi,t + Ɛi,t
LLPi,t = β0 + β1LOANi,t + β2DELLOANi,t + β3NPAi,t + β4DELNPAi,t + β5 CHOi,t + β6DROAi,t + β7SIZEi,t + Ɛi,t
LLPi,t = β0 + β1IHROAi,t + β2HOM%t + β3PBTPi,t + β4 PBTPi,t * IHROAi,t + β5 PBTPi,t *HOM%t + β6 CAPi,t + β7
DELNPAi,t + Ɛi,t
LLPi,t = β0 + β1ALLWi,t + β2NPAi,t + β3DELNPAi,t + β4 CHOi,t + β5 DELLOANi,t + β6 LOANi,t+1 +
∑
βn 10
n=7 LOANCAT i,t-1+ Year Controls + Ɛi,t
LLPi,t = β0 + β1PBTPi,t + β2DELNPAi,t + β3DELNPAi,t-1 + β4 DELNPAi,t-2 + β5CAPi,t-1 + β6SIZEi,t-1 + β7DGDPt + Ɛi,t
LLPi,t = β0 + β1CHOi,t + β2DELNPAi,t + β3INDt + β4COMt + β5SIZEi,t + β6INRETt + β7ALLWi,t + β8DUNRATEi,t +
Ɛi,t

Note: The definitions of variables used in the above specifications are provided in Table 2.

Table 2
Variable definition.
S. No. Variable Name Explanation

1 ALLW beginning value of allowance

2 CAP ratio of equity capital to total assets
3 CHO loan charge-offs net of recovery amount
4 COM proportion of commercial loans in total loans
5 DELLOAN change in loans and advances
6 DELNPA change in gross nonperforming assets
7 DGDP percentage change in per capita GDP
8 DLLP discretionary provision for loan losses (residual value from individual LLP specifications)
9 DROA difference between a bank’s return on assets and sample average return on assets for the year
10 DUNRATE change in unemployment rate
11 GBV gross book value of equity before the allowance for loan losses
12 HOM% the percentage of homogeneous loans (agricultural and personal credit) in a bank’s loan portfolio
13 IHROA an indicator variable that takes a value of 1 if a bank has an above-median return on assets in the year, and 0 otherwise
14 IND proportion of individual loans in total loans
15 INRET Reserve Bank of India Housing Price Index with base year being 2009
16 LLP provision for loan losses
17 LOAN beginning value of loans and advances
18 LOANCAT individual loan categories that include agricultural credit, manufacturing sector loans, services sector loans, and personal loans
19 NDLLP non-discretionary provision for loan losses (fitted value from individual LLP specifications)
20 NPA beginning value of gross nonperforming assets
21 PBTP profit before tax and provision
22 SIZE the natural logarithm of total assets
23 TAS total assets
24 Year Controls dummy variable identifying year of observation

8
National Stock Exchange of India (NSE), Bombay Stock Exchange (BSE).
9
Four new banks were incorporated after the year 2009. These banks have not been excluded from the study to avoid sample construction bias
and result in an unbalanced panel. Our statistical software allows for unbalanced panel fixed effects estimation by removing singleton observations.

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A. Pandey et al. Finance Research Letters xxx (xxxx) xxx

Table 3
Descriptive statistics.
Mean Median Maximum Minimum SD

LLP 0.127 0.078 1.240 − 0.108 0.157

ALLW 0.161 0.095 1.509 0.001 0.202
CAP (%) 11.343 10.445 55.930 5.720 4.682
CHO 0.090 0.056 0.961 0.000 0.114
LOAN 7.652 7.971 15.213 0.392 2.770
DELLOAN 1.103 1.165 4.811 − 2.890 1.022
NPA 0.386 0.192 9.739 0.004 0.686
DELNPA 0.068 0.040 0.966 − 8.764 0.514
PBTP 0.206 0.214 0.516 − 0.191 0.087
SIZE 13.802 13.945 17.421 6.992 1.604
DGDP (%) 0.116 0.110 0.183 0.091 0.026
DROA (%) − 0.001 0.140 4.150 − 33.640 2.087
DUNRATE (%) 0.007 0.002 0.285 − 0.092 0.106
INRET (%) 0.126 0.138 0.222 0.032 0.066

Notes: Descriptive statistics are provided for the key measures employed in the study. The definitions of variables are provided in Table 2. The
variables (LLP, ALLW, CHO, LOAN, DELLOAN, PBTP) are deflated by gross book value (GBV). For robustness, we also use total assets as the scale
deflator (not shown here for brevity).

the proposed model has a higher explanatory power on the discretionary behaviour in emerging countries than that of these nine
specifications that are widely employed in the literature. We use gross book value (GBV) and total assets (TAS) as two scale-deflators to
control for potential scale effects (Barth and Clinch, 2009). All the estimations are performed using pooled regression and panel
fixed-effect methods. For the computation of the coefficients and their significance, we employ heteroscedasticity and autocorrelation
consistent standard errors. Summary statistics of the key variables are provided in Table 3.

5. Empirical results

We report the results from all the nine specifications estimated under the panel fixed-effect method in Tables 4 and 5, employing
GBV and TAS scale-deflators, respectively. The estimations with the pooled regression approach are reported in Appendices 1 and 2.
The results remain qualitatively similar across different scale-deflators and estimation methods. We compare the proposed model
with the nine models, using the five model selection criteria [Adjusted-R2, F-statistic, Root mean square error (RMSE), Akaike

Table 4
LLP specification results with panel fixed-effect method and gross book value (GBV) deflator.
Results from the panel fixed-effect method with GBV deflator
Beatty Liu Kana Wahlen Kim Beck Bushman Collins Beaver

N 341 318 281 287 299 281 273 341 300

NPA 0.005 0.275*** 0.469*** 0.19*** 0.243***
0.26 3.69 5.57 12.31 6.18
CHO 0.637*** 0.485*** 0.657*** 0.922***
6.25 5.31 5.88 11.50
DELNPA 0.174** 0.235*** 0.206*** 0.286*** 0.183*** 0.249*** 0.032
2.32 6.11 12.35 8.46 3.50 6.85 1.40
DELLOAN − 0.005 − 0.002 − 0.039***
− 1.47 − 0.44 − 4.64
DGDP − 0.911***
− 4.03
PBTP 0.732 0.809***
1.00 4.32
Adj. R2 59.65% 32.06% 87.48% 70.82% 85.69% 84.68% 54.35% 79.29% 70.77%
F-value 48.145*** 42.07*** 105.546*** 104.59*** 175.44*** 198.14*** 51.831*** 203.388*** 50.272***

Notes: The table presents the results for all the nine specifications. The details of specifications and variable definitions are provided in Table 1 and
Table 2. ‘N’ denotes the number of observations. Across all the specifications, the results are shown for the variables that are significant for at least one
out of the eighteen models (nine for GBV deflator and nine for TAS deflator). ‘t-statistics’ are provided below the respective coefficients. For the
specification “Bushman”, the variable DELNPA has 1 contemporaneous and 2 lagged terms. In the table, we report the average of all the three terms
and the average of the t-statistics. The coefficients of all the terms are positive, while the third term (and the average of all the three terms) is sig­
nificant at 1% level. ***, ** and * denote significance at 1%, 5% and 10% significance levels respectively.

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 A. Pandey et al.
Table 5
LLP specification results with panel fixed-effect method and total assets (TAS) deflator.
Results from the panel fixed-effects model with TAS deflator
Beatty Liu Kana Wahlen Kim Beck Bushman Collins Beaver

N 341 318 281 287 299 281 273 341 300

NPA 0.004 0.29*** 0.429*** 0.186*** 0.281***
0.23 4.40 5.72 12.12 7.44
CHO 0.713*** 0.509*** 0.737*** 0.939***
9.17 9.32 8.14 20.18
DELNPA 0.171*** 0.262*** 0.203*** 0.305*** 0.178*** 0.286*** 0.03
3.82 8.39 12.57 8.66 3.55 8.11 1.48
DELLOAN − 0.013** − 0.002 − 0.035***
6

− 2.31 − 0.33 − 4.32

DGDP − 0.058***
− 4.48
PBTP 0.91 0.8***
1.34 4.64
2
Adj. R 51.79% 43.26% 87.42% 69.56% 83.77% 84.05% 55.34% 75.88% 69.61%
F-value 33.585*** 34.248*** 105.026*** 98.784*** 189.259*** 189.221*** 53.72*** 124.22*** 152.815***

Notes: The table presents the results for all the nine specifications. The details of specifications and variable definitions are provided in Tables 1 and 2. ‘N’ denotes the number of observations after
incorporating lagged terms of variables. Across all the specifications, the results are shown for the variables that are significant for at least one out of the eighteen models (nine for GBV deflator and nine for
TAS deflator). ‘t-statistics’ are provided below the respective coefficients. For the specification “Bushman”, the variable DELNPA has 1 contemporaneous and 2 lagged terms. In the table, we report the
average of all the three terms and the average of the t-statistics. The coefficients of all the terms are positive, while the third term (and the average of all the three terms) is significant at 1% level. ***, **
and * denote significance at 1%, 5% and 10% significance levels respectively.

Finance Research Letters xxx (xxxx) xxx

 A. Pandey et al.
Table 6
Results from the proposed LLP specification
LLPi,t = β0 + β1NPAi,t + β2CHOi,t + β3DELNPAi,t + β4DELNPAi,t-1 + β5DELNPAi,t-2 + β6DELLOANi,t + β7 DGDPt + β8PBTPi,t + Ɛi,t.
N NPA CHO DELNPA DELNPAlag1 DELNPAlag2 DELLOAN DGDP PBTP Adj. R2 F-value

Panel A: Pooled regression model

GBV deflator 232 0.156*** 0.466*** 0.171*** 0.008* 0.065 − 0.009 − 0.316 0.219*** 91.53% 334.375***
9.50 6.21 9.49 1.88 1.47 − 1.23 − 1.47 2.88
TAS deflator 232 0.165*** 0.463*** 0.18*** 0.01*** 0.063 − 0.008 − 0.014 0.181*** 90.61% 274.821***
9.85 9.91 10.22 3.81 1.42 1.27 1.08 3.14
7

− −
Panel B: Panel regression model
GBV deflator 232 0.166*** 0.406*** 0.178*** 0.007 0.076* − 0.009 − 0.243 0.265*** 85.41% 227.714***
7.31 4.26 7.15 1.48 1.95 − 1.03 − 1.05 2.81
TAS deflator 232 0.165*** 0.405*** 0.177*** 0.008*** 0.072* − 0.008 − 0.017 0.282*** 85.92% 400.975***
7.30 7.44 7.40 3.21 1.83 − 1.00 − 1.42 3.20

Notes: The table presents the results from the proposed LLP specification enumerated above. The results pertaining to pooled regression and panel fixed-effect methods, are shown in the panels A and B,
respectively. ‘N’ denotes the number of observations after incorporating lagged terms of variables. ‘t-statistics’ are provided below the respective coefficients. The definitions of variables used in the above
specification are provided in Table 2. ***, ** and * denote significance at 1%, 5% and 10% significance levels respectively.

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A. Pandey et al. Finance Research Letters xxx (xxxx) xxx

Table 7
Goodness-of-fit (GoF) indicators for LLP specifications.
Panel A: Panel fixed-effect model
GBV deflator TAS Deflator

Adj. R2 F-value RMSE AIC BIC Adj. R2 F-value RMSE AIC BIC
Proposed 85.41% 227.71 4.72% − 6.04 − 5.92 Proposed 85.92% 400.97 0.28% − 11.69 − 11.57
Beatty 59.65% 48.14 7.87% − 5.07 − 5.05 Beatty 51.79% 33.58 0.54% − 10.43 − 10.41
Collins 79.29% 203.39 5.63% − 5.74 − 5.70 Collins 75.88% 124.22 0.38% − 11.12 − 11.09
Beaver 70.77% 50.27 6.77% − 5.37 − 5.33 Beaver 69.61% 152.82 0.43% − 10.88 − 10.84
Kim 85.69% 175.44 4.71% − 6.07 − 5.98 Kim 83.77% 189.26 0.31% − 11.49 − 11.40
Liu 32.06% 42.07 10.22% − 4.52 − 4.43 Liu 43.26% 34.25 0.59% − 10.24 − 10.15
Kana 87.48% 105.55 4.31% − 6.15 − 5.91 Kana 87.42% 105.03 0.27% − 11.70 − 11.45
Bushman 54.35% 51.83 8.36% − 4.91 − 4.82 Bushman 55.34% 53.72 0.50% − 10.54 − 10.45
Beck 84.68% 198.14 4.88% − 5.98 − 5.88 Beck 84.05% 189.22 0.31% − 11.49 − 11.39
Wahlen 70.82% 104.59 6.66% − 5.37 − 5.28 Wahlen 69.56% 98.78 0.42% − 10.92 − 10.83
Panel B: Pooled regression model
GBV deflator TAS Deflator
Adj. R2 F-value RMSE AIC BIC Adj. R2 F-value RMSE AIC BIC
Proposed 91.53% 334.38 5.06% − 5.89 − 5.76 Proposed 90.61% 274.82 0.31% − 11.48 − 11.34
Beatty 68.37% 65.23 8.79% − 4.85 − 4.81 Beatty 57.53% 36.45 0.62% − 10.16 − 10.13
Collins 83.99% 214.39 6.24% − 5.52 − 5.48 Collins 77.49% 124.07 0.45% − 10.79 − 10.75
Beaver 75.10% 58.77 8.13% − 4.99 − 4.94 Beaver 72.28% 179.04 0.52% − 10.51 − 10.46
Kim 89.81% 254.38 5.17% − 5.87 − 5.77 Kim 86.22% 178.15 0.36% − 11.19 − 11.09
Liu 46.23% 33.21 11.56% − 4.27 − 4.17 Liu 46.85% 41.24 0.69% − 9.89 − 9.80
Kana 91.39% 157.43 4.71% − 5.97 − 5.71 Kana 89.05% 120.86 0.32% − 11.36 − 11.10
Bushman 65.93% 76.20 9.71% − 4.60 − 4.50 Bushman 58.67% 56.16 0.63% − 10.09 − 9.99
Beck 89.09% 286.66 5.42% − 5.77 − 5.65 Beck 85.93% 214.74 0.37% − 11.14 − 11.02
Wahlen 80.35% 168.09 7.20% − 5.21 − 5.10 Wahlen 76.16% 131.54 0.46% − 10.69 − 10.59

Notes: GoF indicators (Adj. R2, F-value, Root Mean Square Error (RMSE), Akaike Information Criterion (AIC), and Bayesian Information Criterion
(BIC)) are shown. Panels A and B provide the results corresponding to panel fixed-effect and pool models, respectively. The results are shown cor­
responding to the deflators, namely, gross book value (GBV) and total assets (TAS). The details of specifications and variable definitions are provided
in Tables 1 and 2.

Appendix 1 LLP specification results with pooled regression and gross book value (GBV) deflator.

Results from the pooled regression model with GBV deflator

Beatty Liu Kana Wahlen Kim Beck Bushman Collins Beaver

N 341 318 281 287 299 281 273 341 300

NPA 0.006 0.288*** 0.545*** 0.191*** 0.244***
0.26 4.30 6.28 13.24 6.19
CHO 0.637*** 0.508*** 0.699*** 1.046***
7.29 6.21 6.36 12.24
DELNPA 0.18** 0.256*** 0.207*** 0.306*** 0.212*** 0.249*** 0.042
2.08 6.31 13.16 8.83 3.49 6.92 1.38
DELLOAN − 0.002 − 0.001 − 0.034***
− 0.48 − 0.13 − 3.75
DGDP − 0.878***
− 5.55
PBTP 0.453 0.55***
0.91 4.48
Adj. R2 68.37% 46.23% 91.39% 80.35% 89.81% 89.09% 65.93% 83.99% 75.10%
F-value 65.227*** 33.207*** 157.432*** 168.091*** 254.381*** 286.664*** 76.196*** 214.387*** 58.77***

Notes: The table presents the results for all the nine specifications. The details of specifications and variable definitions are provided in Tables 1 and 2.
‘N’ denotes the number of observations. ‘t-statistics’ are provided below the respective coefficients. For the specification “Bushman”, the variable
DELNPA has 1 contemporaneous and 2 lagged terms. In the table, we report the average of all the three terms and the average of the t-statistics. The
coefficients of all the terms are positive, while the third term (and the average of all the three terms) is significant at 1% level. ***, ** and * denote
significance at 1%, 5% and 10% significance levels respectively.

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A. Pandey et al. Finance Research Letters xxx (xxxx) xxx

Appendix 2 LLP specification results with pooled regression and total assets (TAS) deflator.

Results from the pooled regression model with GBV deflator

Beatty Liu Kana Wahlen Kim Beck Bushman Collins Beaver

N 341 318 281 287 299 281 273 341 300

NPA 0.005 0.288*** 0.491*** 0.195*** 0.276***
0.25 5.19 6.18 11.11 8.00
CHO 0.702*** 0.542*** 0.732*** 0.959***
9.73 8.47 9.36 21.07
DELNPA 0.193*** 0.301*** 0.214*** 0.342*** 0.217*** 0.281*** 0.032
3.79 9.01 11.72 8.85 3.10 8.86 1.37
LOAN 0.007 0.016*
0.75 1.76
DELLOAN 0.006 0.015 − 0.033***
0.69 1.58 − 4.08
DGDP − 0.052***
− 4.63
PBTP 0.921* 0.325***
1.80 2.84
Adj. R2 57.53% 46.85% 89.05% 76.16% 86.22% 85.93% 58.67% 77.49% 72.28%
F-value 36.447*** 41.245*** 120.862*** 131.544*** 178.147*** 214.741*** 56.156*** 124.067*** 179.036***

Notes: The table presents the results for all the nine specifications. The details of specifications and variable definitions are provided in Tables 1 and 2.
‘N’ denotes the number of observations. ‘t-statistics’ are provided below the respective coefficients. For the specification “Bushman”, the variable
DELNPA has 1 contemporaneous and 2 lagged terms. In the table, we report the average of all the three terms and the average of the t-statistics. The
coefficients of all the terms are positive, while the third term (and the average of all the three terms) is significant at 1% level. ***, ** and * denote
significance at 1%, 5% and 10% significance levels respectively.

information criterion (AIC), and Bayesian Information Criterion (BIC)]. The corresponding results are reported in Tables 6 and 7. These
results indicate that the proposed LLP specification has more explanatory power, as compared to the nine specifications selected in the
study. Our observation regarding goodness-of-fit is mostly consistent across different model selection criteria. Moreover, across
different methods and choice of scale-deflators, our results remain robust.

6. Conclusion

Emerging countries have substantially different standards for accounting of loan losses when compared to the developed countries.
The banking regulator and standard setters in emerging markets often rely on the rule-based approach to NPA classification and loan
loss provisioning. We offer evidence for the role of accounting standards and regulatory mechanisms in influencing discretionary
managerial behaviour. We propose an LLP specification that is more efficient in explaining the discretionary behaviour under the rule-
based accounting standards prescribed by the Indian banking regulator. We compare this specification with the nine LLP models
employed widely in the banking literature, using five different model selection criteria. Our proposed model performs better than these
nine specifications. Policymakers, regulators, capital market participants, academics, auditors, and standard setters can employ this
specification to examine the information content of LLP and gain important insights on the discretionary and non-discretionary
behaviour of bank managers. Portfolio managers can employ the proposed specification to better identify the extent of discretion
exercised by the bank management and understand motives behind managerial behaviour.

Author statement

This research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors.

Declarations of Competing Interest

None.

Supplementary materials

Supplementary material associated with this article can be found, in the online version, at doi:10.1016/j.frl.2021.102068.

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