Bank managerial behaviour, policy and credit risk management: An Australasian study : A thesis submitted in partial fulfilment of the requirements for the Degree of Doctor of Philosophy at Lincoln University

Abstract

This research explores the influence of cognitive biases, supervisory power and regulatory frameworks on judgement errors in banks' credit risk management practices. The focus is on sources of error in estimates of non-performing assets and loan loss provisions against a backdrop of changes in accounting and prudential regulations and incentives/disincentives embedded in a country’s tax code. The objective was to (i) understand how managerial sentiment and prudence impact credit risk decisions, (ii) examine the effectiveness of accounting and prudential regulation in influencing bank manager behaviour, and (iii) explore the interactions between tax policy and macroprudential frameworks in regulating bank behaviour. The study enabled the exploration of tensions between accounting, prudential and tax regulation, and between the bank manager and their operating environment. Using a concurrent transformative design, quantitative and qualitative data were simultaneously collected for an Australasian sample (Australia and New Zealand), consisting of bank data and nine experts. Though the region abides by international norms and standards, regulators and market participants view Australasia as idiosyncratic, consequently influencing behavioural outcomes. The quantitative analysis using country-specific and combined samples of Australasian banks suggests a negative contemporaneous relationship between managerial sentiment and loan loss provisioning practices. The results also demonstrate the role of managerial prudence in influencing the magnitude of provisioning estimates, further validating the need to understand how short-termism impacts credit risk decisions. The findings reveal the positive impact that banking supervisory power (the regulator) has on the disclosures of non-performing assets and loan loss provisioning. Supervisory intensity is an under-researched topic, but some current studies show that, in some cases, supervisory power might not be the most optimal vehicle to deliver the best behavioural outcomes. Concurrently, the qualitative results from the expert interviews with prudential and tax regulators, academics, consultants and bankers reveal the potential to use the tax code as an adjunct to the prudential regulatory framework as advocated by global organisations like the International Monetary Fund. However, certain ideological thresholds need to be crossed, given hesitancy about the impact of reforms on tax revenues, the power of bank lobbyists and the revolving door between the sector and regulators exposing the regulatory process to intellectual capture. The findings have implications for the timeliness and transparency of recognising provisions and non-performing assets and on contracting decisions given the role of financial reporting quality in facilitating contracts between bank managers, boards, investors and creditors. The study contributes to behavioural finance literature, earnings and capital management literature, accounting and prudential regulation, navigating political agendas in banking, and adds to the global discourse concerning the role of taxation in banking. Given the presence of cognitive biases and short-termism in credit risk management in Australasia and the need to question the merits of traditional banking regulation, this study has broad implications for understanding managerial behaviour, contracting decisions, standard-setting and prudential regulation, financial reporting, and tax reform.