Applying Benford’s Law to Detect Accounting Data Manipulation in the Banking Industry

Abstract

We utilise Benford’s Law, which predicts the frequencies in different digits in data, to test if balance sheet and income statement data used to assess bank soundness were manipulated prior to, and also during, the global financial crisis. We find that banks adjust loan loss provisions to manipulate earnings and income upwards. Distressed institutions that have stronger incentives to conceal their financial difficulties also manipulate loan loss allowances and non-performing loans downwards. Moreover, manipulation is magnified during the crisis and expands to encompass regulatory capital.