Do Loan Loss Provisions enhance Profitability through Tax Saving : Evidence for Pakistani Banking Sector

In this study, we evaluate the impact of Loan Loss provisions (LLP) on profitability ratios and income smoothing in the conventional banking sector of Pakistan. While there was no prior research that have been observed that the impact of loan loss provisions in the conventional banking sector of Pakistan. This study is the first to inspect the impact of Loan Loss Provision on profitability ratios as well as for the income smoothing purpose. Loan Loss Provision is used as a manipulation tool over time especially in high earning periods which diminished in profitability ratios. For this purpose, data of 20 conventional banks were taken for the period of 2006 to 2018. The Results suggested that the Loan Loss Provision had a significant negative impact on profitability ratios. Lower profitability would lead to tax savings, hence Banks used LLP as a tool to increase the cash flows due to tax savings. Other factors like non-performing loans have a significant and negative effect on profitability, whereas size has a positive effect. This study recommends that the conventional banks of Pakistan adjust their loan Loss Provision for income smoothing purpose which leads to the negative impact, on profitability ratios return on assets (ROA) return on equity (ROE) and net profit margin (NPM). This study helps to comprehend all stakeholders of banks concerning the manipulation of Loan Loss Provision and its impact on financial ratios expressly in high earning periods