The three pillars of Basel II and the quality of accounting information in worldwide banks

Abstract

The recommendations introduced by Basel II can be grouped into three pillars: regulatory capital requirements, supervisory review process and market discipline. The financial crisis revealed weaknesses in banking and supervisory practices as well as market discipline. In 2010, Basel III standards were proposed in order to further strengthen the banking system and its stability through more rigid regulatory and supervision systems. This impetus to reinforce pillars 1 and 2, leads us to consider whether Basel II has not worked or has not been enough. The thesis is divided into three chapters: The first is entitled "Income smoothing through loan loss provisions: cultural and cyclical factors" and analyzes the explanatory factors of income smoothing in the banking sector during the period 1997-2009. Moreover, we try to verify if there are different cultural behaviors and which are the characteristics of those countries that provide better accounting information. We obtain that loan loss provisions in banking carry out a countercyclical role, showing a differentiated behavior in periods of expansion and recession. It is confirmed that banks manage the result through loan loss provisions during the period 2005-2009, after the implementation of IFRS, although they do so more intensively after 2008, with the introduction of Basel II and the beginning of the crisis. We confirm that both uncertainty avoidance and individualism have a negative effect on the amount of loan loss provisions, although only countries with an individualistic tendency smooth their incomes through loan loss provisions. The second chapter, "Regulation, supervision and accounting conservatism in banks", links the pillars of Basel II with conservatism, i.e. timely and early recognition of bank insolvencies. We analyze market discipline, measured through three proxies - listing status, capital structure and market concentration - to verify its role versus the two traditional pillars of regulation and supervision, measured through the indicators of Barth, Caprio and Levine (2006). Our results suggest that the rigor or rigidity of regulatory and supervisory regimes is associated with greater accounting conservatism and that a more robust market discipline is also associated with greater conservatism. In addition, the regulatory and supervisory mechanisms operate to cover the failures of market discipline in countries where it is weak. We also document differences in legal institutions and the culture of transparency between countries, through the index of disclosure requirements, which is negatively related to conservatism. The third chapter, "Accounting conservatism in banks and the drop in supply of loans during the financial crisis" calculates the impact of two different measures of conservatism on the supply of loans during the crisis in the specific case of Spain. We study the impact of the lack of quality in accounting information on a credit restriction in times of crisis. In the case of savings banks, conservatism significantly mitigates the drop in the supply of loans during recessions; those that have accumulated reserves above the minimum level required by law, will suffer a smaller fall in lending activity. At the beginning of the crisis there is a general fall in loans, but as the years go by, conservatism increasingly mitigates the credit crunch. Given the results obtained, we can say that the standards set by Basel II have worked correctly in the period of study, but have proved to be insufficient. Our results therefore strongly support the Basel III reaction of intensively reinforcing the traditional Basel II regulatory and supervisory pillars.