Loan loss provisioning by Italian banks: Managerial discretion, relationship banking, functional distance and bank risk

This paper investigates the loan loss provisioning behaviour of Italian banks during the period 2006-2013. We examine the main discretionary and non-discretionary determinants of loan loss provisions (LLPs) and explicitly investigate the role of bank's functional distance, geographic diversification and risk. Empirical results suggest that LLPs by Italian banks are mainly driven by non-discretionary factors related to expected credit risk. Moreover, we find that distantly managed banks adopt a more prudent provisioning approach, whereas small local cooperative credit banks have a lower level of LLPs. We also show that LLPs are higher in regional banking systems with higher loan concentration and lower degree of competition. Finally, we find that banks facing increasing levels of risk are not only characterised by higher LLPs, but also have a higher tendency to engage in earnings management practices to stabilise their income flows over time.