Fiscal Support, QE and Income-smoothing in European Banks during the COVID-19 Crisis
Fiscal Support, QE and Income-smoothing in European Banks during the COVID-19 Crisis

Summary/Abstract: This study examines how fiscal and monetary policy responses to the COVID-19 crisis influenced banks’ income smoothing through loan-loss provisions (LLPs) in the European Economic Area (EEA). Using a panel of 1,122 commercial banks from 29 countries between 2011 and 2020, we investigate whether the intensity of income smoothing varied with the scale of public support. Fiscal liquidity measures and the European Central Bank’s quantitative easing (QE) under the Pandemic Emergency Purchase Programme (PEPP) serve as proxies for government and monetary interventions. The results show that both fiscal and monetary support reduced average LLP levels but simultaneously strengthened the link between earnings and provisioning, indicating increased income-smoothing behavior during the pandemic. This pattern reflects two complementary mechanisms: the crisis-severity channel, where larger policy interventions corresponded to deeper economic stress, and the moral-hazard channel, where public backstops expanded managerial discretion in provisioning. Overall, the findings suggest that large-scale stabilization policies mitigated credit risk and preserved financial stability but also encouraged more discretionary accounting behavior, underscoring a potential trade-off between crisis management and the transparency of banks’ financial reporting.

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