Loan loss provisions, bank valuations and discretion: a comparative study between conventional and Islamic banks

Marwa Elnahas, Marwan Izzeldin, Omneya H. Abdelsalam

Research output: Contribution to journalArticle

Abstract

This study investigates the use of reported loan loss provisions (LLP) by investors in their valuations of banks within the Middle East and North Africa region between the years 2006 and 2011. We decompose LLP into discretionary and non-discretionary components to test for differential valuations in the two banking sectors. We use alternative criteria to define the components of LLP in banks: loan quality/size and earnings management/manipulation incentives. We employ a price-level valuation model estimated using two-stage analyses. We find that LLP has positive value relevance to investors in both banking sectors. Investors in Islamic banks price the discretionary component relatively lower than their conventional counterparts. We attribute this result to differences in product and governance structures as well as to the religious perception of Islamic banking. In both banking sectors, investors construe an increase in the non-discretionary component as irrelevant valuation information. Our results are relevant to bank regulators in showing the signalling effect of LLP to bank value and stability.

Original languageEnglish
JournalJournal of Economic Behavior and Organization
Volume103
Early online date12 Sep 2013
DOIs
Publication statusPublished - Jul 2014

Fingerprint

Islamic financial institutions
Comparative study
Discretion
Loan loss provisions
Investors
Banking sector
Manipulation
Valuation model
Islamic banking
Price level
Governance structure
Incentives
Product structure
Value relevance
Middle East and North Africa
Earnings management
Bank loans

Keywords

  • conventional banks
  • earnings management
  • islamic banks
  • loan loss provisions
  • value relevance

Cite this

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abstract = "This study investigates the use of reported loan loss provisions (LLP) by investors in their valuations of banks within the Middle East and North Africa region between the years 2006 and 2011. We decompose LLP into discretionary and non-discretionary components to test for differential valuations in the two banking sectors. We use alternative criteria to define the components of LLP in banks: loan quality/size and earnings management/manipulation incentives. We employ a price-level valuation model estimated using two-stage analyses. We find that LLP has positive value relevance to investors in both banking sectors. Investors in Islamic banks price the discretionary component relatively lower than their conventional counterparts. We attribute this result to differences in product and governance structures as well as to the religious perception of Islamic banking. In both banking sectors, investors construe an increase in the non-discretionary component as irrelevant valuation information. Our results are relevant to bank regulators in showing the signalling effect of LLP to bank value and stability.",
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Loan loss provisions, bank valuations and discretion : a comparative study between conventional and Islamic banks. / Elnahas, Marwa; Izzeldin, Marwan; Abdelsalam, Omneya H.

In: Journal of Economic Behavior and Organization, Vol. 103, 07.2014.

Research output: Contribution to journalArticle

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