Bank Funding Strategy and Income Smoothing Practices in Nigeria

Abstract

The regulators’ provision of bailouts to troubled banks accentuates the connection between level of funding and bank financial condition. This scenario has been characteristic of Nigerian deposit money banks (DMBs) in the last decade and followed by a number of reforms including adoption of International Financial Reporting Standards (IFRSs). This prompted the study’s examination of nexus between bank funding strategy and income smoothing practices achievable via adjustments to loan loss provisions (LLPs) considering IFRSs adoption and solvency risk. Bank-level unbalanced panel data were hand-extracted from the annual reports of a sample of 16 DMBs for the period 2007-2017. Data were analyzed using appropriate panel regression model subsequent to derivation of discretionary provision for loan losses (DPL) used to measure income smoothing and index of funding strategy (FSI) as a measure of overall funding strategy. The results showed that bank funding drive prompts Nigerian DMBs’ income smoothing practices via DPL regardless of their solvency status and reflects majorly in their motive for external financing, deposit and non-deposit funding other than internal funding strategy. However, reduction was noticeable during IFRS given the observed inverse relationship between funding strategy and Nigerian DMBs’ income smoothing practices. Despite improved financial reporting quality during IFRS, the mixed results obtained in the funding strategy-DPL nexus of Nigerian DMBs threatened by risk of insolvency call for increased level of oversights and additional reforms by the regulators. The need for regulators to re-sharpen their supervisory tools as Nigerian DMBs switch from IAS 39 to more discretions-inclined IFRS 9 for loan loss reporting was also advocated. This study is unique for derivation of FSI and joint test of IFRS-solvency risk moderating influence.