6. Conclusion
This study examines whether European banks use CF for earnings management purposes. I focus on two types of earnings management strategy: income-smoothing or income-increasing earnings management by examining the statistical relationship between CF and EBCF. I find that European banks use CF to smooth earnings so that earnings are never too high or too low and this behaviour is more pronounced among NTBTF European banks compared to TBTF European banks. I also find that the CF of NTBTF banks is procyclical with fluctuating economic conditions but not for TBTF banks. Also, I find evidence for income-increasing earnings management during the post-crisis period for larger European banks and when ex post interest income levels are taken into account. Therefore, I conclude that the propensity for European banks to use CF to engage in income-increasing earnings management significantly depends on bank size and ex post interest margin considerations.
Finally, bank regulators and policy researchers in Europe should be aware that the income generated from non-interest activities are rather used to manipulate reported earnings as an income-increasing or income-smoothing strategy. With regard to the income diversification debate, the findings of this study contribute to the diversification debate and support the argument that non-interest income yields lower diversification benefits to European banks and increase bank (systematic) risk. Therefore, bank regulators in Europe should be aware that European banks’ reliance on non-interest income increases bank risk rather than reducing risk.
