This paper investigates whether and at what extent private firms reduce the quality of their accruals in order to signal a better portrait to the bank and obtain new or larger bank loans. We measure earnings discretionary accruals of a sample of Italian private firms, testing whether new and larger bank loans are associated with a higher (lower) quality of earnings in borrowers' financial reporting. We study bank loan levels and changes and how they impact discretionary accruals and found that, surprisingly, private firms' discretionary accruals are systematically positively affected by an increase in bank loans, although they are negatively affected by the credit worthiness rating assigned to the borrowers. We find that the monitoring role of the banking system with regard to the adoption of discretionary accruals is effective only when the loan is very large. This paper may have implications for policy-makers as it contributes to the understanding of the shortcomings of the banking regulatory system. This is an extremely relevant issue since the excessive amount of non-performing loans held by Italian banks recently threatened the stability of the European Banking Union as a whole.
