Macroprudential Policy Tightening, Loan Loss Provisioning and Income Smoothing: Empirical Evidence from European Economic Area Banks

In this study, we provide evidence of the effects of macroprudential policy tightening on loan loss provisions (LLP) and income smoothing of European Economic Area (EEA) banks. Overall, we find that tightening actions of macroprudential policy reduce LLP, but the results depend on the period of analysis: the effect is positive in the pre-Basel III period (1996-2010), and it turns negative after 2010. Policy tightening increases (respectively decreases) income smoothing in the pre-Basel period (respectively Basel III period). We also find that our results depend on the category of macroprudential instruments. In particular, tools relating to LLP policy and taxes are associated with increased LLP and income smoothing in the pre-Basel III period. This outcome changes direction under the Basel III regulatory regime. We also show that the heterogeneity of the effects of the policy on LLP and income smoothing depends on the tool, on the type of the policy change (an activation of a new tool versus a recalibration of existing tools) and on market significance of a bank.