Bank income smoothing behaviours under expansionary and recessionary economic environments: New evidence using micro‐data sample

The income smoothing (IS) literature connected with changes in the external environment provides unclear results whether this phenomenon occurs in expansion or in crisis. Given that a substantial amount of credit risk is generated in retail banking, this study exploits a large number of micro‐loan portfolio level data of a systemic Greek bank and examines, for the first time, the IS behaviour at the retail banking level, contrasting the expansion period (2006–2008) with the financial crisis period (2009–2011). This specific case study provides more granular data compared with traditional archival studies, thus allowing the immediate and more frequent identification of exogenous (such as crisis effects) and endogenous (such as the geographic origination of loan portfolios) features that may affect IS practices. Based on the association between pre‐provision loan income and loans loss provisions as a proxy for IS, we employ the robust Mean Group estimator (Pesaran and Smith, Journal of Econometrics, 1995;68(1):79–113) and find that this association is higher in expansionary periods and declines in recession. Moreover, we conclude that the IS behaviour is affected by geographical features of loan portfolios.