Answer to Question #248675 in Finance for jackjack

Question

How does loss provision affect financial institution's capital and share price?

Answer 1

Empirical studies

have shown that loan-loss provisions are used mainly in three types of discretional practices:

1) to smooth income; 2) to manage capital; and 3) to signal financial strength

The private-control-benefits hypothesis states that managers, acting in the best interests of

their shareholders, would smooth earnings in order to minimize the perceived riskiness of a

bank’s earnings and thereby maximize the bank’s share price.

Provisions for possible losses on ships affect the undistributed profits of banks, which in turn affects the capital and the value of shares.