Does financial inclusion create incentive for earnings management? Evidence from BRICS

We investigate the impact of financial inclusion (FI) on earnings management (EM) practices in banks domiciled in Brazil, Russia, India, China, and South Africa (BRICS) and contribute to the debate on whether FI makes business sense for banks. By developing an FI index (FII), we show that FI promotes income-increasing EM (IIEM) in BRICS banks, while its effect on income-decreasing EM (IDEM) remains insignificant. A plausible explanation is that rising credit risk outweighs the benefits of FI, such as low-cost deposits and a broad customer base, thereby having a negative impact on earnings and creating incentives for banks to manage earnings upward, which in turn compromises the reporting quality of earnings. Notably, the impact of FI on bank EM is most pronounced for state-owned banks. Our findings remain robust to alternative specifications. The results help policymakers consider a differentiated strategy by facilitating access to banking services while imposing restrictions or limitations on credit to individuals and firms with questionable creditworthiness. JEL Classification: G21, G28, M41