The nexus between IFRS 9 and rule of law on banks' earnings volatility

Purpose This paper aims to study the effects of IFRS 9 adoption and the moderating role of rule of law (RoL) on earnings volatility of banks. Design/methodology/approach The sample consists of banks from 17 G20 countries from 2016 to 2019. Pooled and fixed effect regression analyses are used to test if IFRS 9 adoption, RoL and the interaction effects between them have any significant effects on banks' earnings volatility. Additionally, the Generalised Method of Moments (GMM) was employed to address endogeneity issue and the mediating role of earnings management is examined. Findings This study offers three important findings. Firstly, the study finds that banks from high RoL countries in general have lower volatility. Secondly, there is a significant decline in earnings volatility after the adoption of IFRS 9. Finally, the study provides evidence that the relationship between IFRS 9 and earnings volatility is moderated by RoL. Practical implications The findings confirm the effectiveness of IFRS 9 in reducing earnings volatility. They also highlight the importance for countries of weaker institutional quality (low RoL) to complement with stricter accounting standards. However, improving legal or institutional frameworks alone may not be sufficient. Those frameworks must be effective in constraining opportunistic earnings manipulation to have a meaningful impact on earnings volatility. Originality/value Unlike prior studies that examined market-based volatility or examined the impact on loan loss provision, loan impairments and non-performing loans, this study offers new insights to the effect of IFRS 9 adoption and a country's quality of legal framework on banks' earnings volatility.