Federal Deposit InsuranceCorporation• Center for Financial Researchh
Sanjiv R. Das
Darrell Duffie
Nikunj Kapadia
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
FDIC Center for Financial Research
Working Paper
No. 2005-05
Regulatory Capital and Earnings Management in Banks:
The Case of Loan Sales and Securitizations
N. Emre Karaoglu
May 2005
Sanjiv R. Das
Darrell Duffie
Nikunj Kapadia
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
FDIC Center for Financial Research
Working Paper
No. 2005-05
Regulatory Capital and Earnings Management in Banks:
The Case of Loan Sales and Securitizations
N. Emre Karaoglu
May 2005
Regulatory Capital and Earnings Management in Banks: The Case of
Loan Sales and Securitizations
by
N. Emre Karaoglu*
Leventhal School of Accounting
University of Southern California
Los Angeles, CA 90089-0441
karaoglu@marshall.usc.edu
February 1, 2005
FDIC Center for Financial Research Working Paper No. 2005-05
ABSTRACT
In this paper, I investigate whether ba nks use loan sales a nd securitizations ( loan
transfers) to manage regulatory capital and earnings . My analysis suggests that banks
use gains from loan transfers to influence both reported earnings and regulatory capital
after controlling for other economic motivations. The gains can be attributed both to
cherry-picking of loans whose market values exceed their book values and also to
overvaluation of the retained interests that are carried at fair market value in the case of
securitizations. In addition, the use of securitizations for financial statement management
is positively associated with the degree of financial reporting di scretion available to
managers. Finally, regulatory capital considerations seem to play a significant role in the
decision to transfer loans, while earnings management considerations are more important
in the calculation of reported gains conditi onal on performing a transf er, particularly in
the case of securitizations.
Key words: securitization, loan sales, accounting, capital standards, risk measurement
JEL Classification: G18, G14, G21, M41
CFR research programs: bank regulatory policy, risk measurement
* This paper is based partly on my dissertation at Northwestern University. I am grateful to my
dissertation committee Elizabeth Keating, Robert Korajczyk, Robert Magee, and especially to
Thomas Lys (Chair) for their invaluable sugg estions and guidance. I also thank Walter
Blacconiere, Daniel Cohen, Robert DeYoung, Ronald Dye, Kathleen Hagerty, Ole-Kristian Hope,
Edward Kane, Shiva Rajgopal, Lawrence Revsine, Katherine Samolyk, Catherine Schrand, Haluk
Unal, Mark Vaughan, and Beverly Walther, seminar participants at Chicago, Berkeley,
Washington, Indiana, Toronto, Northwestern, Buffalo, Baruch, Southern Methodist, the FDIC,
and FDIC Journal of Financial Research Conference for very useful comments and Jack Reidhill
(FDIC) for sharing valuable insights about secu ritization related regulations. I gratefully
acknowledge the financial support from the FDIC Center for Financial Research. Any remaining
errors are mine.
Loan Sales and Securitizations
by
N. Emre Karaoglu*
Leventhal School of Accounting
University of Southern California
Los Angeles, CA 90089-0441
karaoglu@marshall.usc.edu
February 1, 2005
FDIC Center for Financial Research Working Paper No. 2005-05
ABSTRACT
In this paper, I investigate whether ba nks use loan sales a nd securitizations ( loan
transfers) to manage regulatory capital and earnings . My analysis suggests that banks
use gains from loan transfers to influence both reported earnings and regulatory capital
after controlling for other economic motivations. The gains can be attributed both to
cherry-picking of loans whose market values exceed their book values and also to
overvaluation of the retained interests that are carried at fair market value in the case of
securitizations. In addition, the use of securitizations for financial statement management
is positively associated with the degree of financial reporting di scretion available to
managers. Finally, regulatory capital considerations seem to play a significant role in the
decision to transfer loans, while earnings management considerations are more important
in the calculation of reported gains conditi onal on performing a transf er, particularly in
the case of securitizations.
Key words: securitization, loan sales, accounting, capital standards, risk measurement
JEL Classification: G18, G14, G21, M41
CFR research programs: bank regulatory policy, risk measurement
* This paper is based partly on my dissertation at Northwestern University. I am grateful to my
dissertation committee Elizabeth Keating, Robert Korajczyk, Robert Magee, and especially to
Thomas Lys (Chair) for their invaluable sugg estions and guidance. I also thank Walter
Blacconiere, Daniel Cohen, Robert DeYoung, Ronald Dye, Kathleen Hagerty, Ole-Kristian Hope,
Edward Kane, Shiva Rajgopal, Lawrence Revsine, Katherine Samolyk, Catherine Schrand, Haluk
Unal, Mark Vaughan, and Beverly Walther, seminar participants at Chicago, Berkeley,
Washington, Indiana, Toronto, Northwestern, Buffalo, Baruch, Southern Methodist, the FDIC,
and FDIC Journal of Financial Research Conference for very useful comments and Jack Reidhill
(FDIC) for sharing valuable insights about secu ritization related regulations. I gratefully
acknowledge the financial support from the FDIC Center for Financial Research. Any remaining
errors are mine.