Do Banks Provision for Bad Loans in Good Times? Empirical Evidence and Policy Implications

Recent debate about the pro-cyclical effects of bank capital requirements, has ignored the important role that bank loan loss provisions play in the overall framework of minimum capital regulation. It is frequently observed that under-provisioning,...

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Main Authors: Cavallo, Michele, Majnoni, Giovanni
Format: Policy Research Working Paper
Language:English
en_US
Published: World Bank, Washington, DC 2014
Subjects:
Online Access:http://documents.worldbank.org/curated/en/2001/06/1490107/banks-provision-bad-loans-good-times-empirical-evidence-policy-implications
http://hdl.handle.net/10986/19607
id okr-10986-19607
recordtype oai_dc
spelling okr-10986-196072021-04-23T14:03:43Z Do Banks Provision for Bad Loans in Good Times? Empirical Evidence and Policy Implications Cavallo, Michele Majnoni, Giovanni ACCOUNTING PRACTICES ACCOUNTING PROCEDURES ACCOUNTING RULES ACCOUNTING TREATMENT AGENCY PROBLEMS ANNUAL ACCOUNTS ASSETS ASYMMETRIC INFORMATION BALANCE SHEET BALANCE SHEETS BANK CAPITAL BANK CAPITAL REGULATION BANK DEPOSITS BANK EARNINGS BANK LENDING BANK LIQUIDITY BANK LOANS BANK REGULATION BANKING SECTOR BANKING SUPERVISION BANKING SYSTEM BANKS CAPITAL REGULATION CAPITAL REQUIREMENT CAPITAL REQUIREMENTS COMMERCIAL BANKS COMPULSORY RESERVES CONSOLIDATION COST OF CAPITAL CREDIT RISK DEPOSITS DIVIDEND POLICY DIVIDENDS ECONOMETRIC EVIDENCE ECONOMICS EXPECTED VALUES FINANCIAL INSTITUTIONS FINANCIAL INTERMEDIATION FINANCIAL REGULATION FINANCIAL SECTOR FINANCIAL STABILITY FISCAL DEFICITS GDP GOVERNMENT BONDS GROWTH RATE INCOME INCOME STATEMENTS INCOME TAXES INSTITUTIONAL DEVELOPMENT INTEREST INCOME INTEREST RATE LEGAL PROVISIONS LOAN CLASSIFICATION LOAN LOSS PROVISIONS LOSS RATIO MARKET DISCIPLINE OPERATING COSTS OPERATING INCOME PORTFOLIO PORTFOLIO DIVERSIFICATION PORTFOLIOS PREMIUMS PRESENT VALUE PROFIT MAXIMIZATION PROFITABILITY PROVISIONING PRUDENTIAL REGULATIONS PUBLIC DEBT PUBLIC FINANCE PUBLIC OWNERSHIP RATES REGULATORY FRAMEWORK RESERVES RETAINED EARNINGS RISK MANAGEMENT RISK MEASUREMENT RISK PREMIUM SHAREHOLDERS SOLVENCY SUBSIDIARY TAX TAX INCENTIVES TAX REVENUES TAXATION TAXES TRANSPARENCY WRITE OFFS Recent debate about the pro-cyclical effects of bank capital requirements, has ignored the important role that bank loan loss provisions play in the overall framework of minimum capital regulation. It is frequently observed that under-provisioning, due to inadequate assessment of expected credit losses, aggravates the negative effect of minimum capital requirements during recessions, because capital must absorb both expected, and unexpected losses. Moreover, when expected losses are properly reflected in lending rates, but not in provisioning practices, fluctuations in bank earnings magnify true oscillations in bank profitability. The relative agency problems faced by different stakeholders, may help explain the prevailing, and often unsatisfactory institutional arrangements. The authors test their hypotheses with a sample of 1,176 large commercial banks - 372 of them in non-G10 countries - for the period 1988-99. After controlling for different country-specific macroeconomic, and institutional features, they find robust evidence among G10 banks, of a positive association between loan loss provisions, and banks' pre-provision income. Such evidence is not confirmed for non-G10 banks, which on average, provision too little in good times, and are forced to increase provisions in bad times. The econometric evidence shows that the protection of outsiders' claims - the claims of minority shareholders in common law countries, and of fiscal authorities in countries with high public debt - on bank income, has negative effects on the level of bank provisions. 2014-08-21T20:20:56Z 2014-08-21T20:20:56Z 2001-06 http://documents.worldbank.org/curated/en/2001/06/1490107/banks-provision-bad-loans-good-times-empirical-evidence-policy-implications http://hdl.handle.net/10986/19607 English en_US Policy Research Working Paper;No. 2619 CC BY 3.0 IGO http://creativecommons.org/licenses/by/3.0/igo/ World Bank, Washington, DC Publications & Research :: Policy Research Working Paper Publications & Research
repository_type Digital Repository
institution_category Foreign Institution
institution Digital Repositories
building World Bank Open Knowledge Repository
collection World Bank
language English
en_US
topic ACCOUNTING PRACTICES
ACCOUNTING PROCEDURES
ACCOUNTING RULES
ACCOUNTING TREATMENT
AGENCY PROBLEMS
ANNUAL ACCOUNTS
ASSETS
ASYMMETRIC INFORMATION
BALANCE SHEET
BALANCE SHEETS
BANK CAPITAL
BANK CAPITAL REGULATION
BANK DEPOSITS
BANK EARNINGS
BANK LENDING
BANK LIQUIDITY
BANK LOANS
BANK REGULATION
BANKING SECTOR
BANKING SUPERVISION
BANKING SYSTEM
BANKS
CAPITAL REGULATION
CAPITAL REQUIREMENT
CAPITAL REQUIREMENTS
COMMERCIAL BANKS
COMPULSORY RESERVES
CONSOLIDATION
COST OF CAPITAL
CREDIT RISK
DEPOSITS
DIVIDEND POLICY
DIVIDENDS
ECONOMETRIC EVIDENCE
ECONOMICS
EXPECTED VALUES
FINANCIAL INSTITUTIONS
FINANCIAL INTERMEDIATION
FINANCIAL REGULATION
FINANCIAL SECTOR
FINANCIAL STABILITY
FISCAL DEFICITS
GDP
GOVERNMENT BONDS
GROWTH RATE
INCOME
INCOME STATEMENTS
INCOME TAXES
INSTITUTIONAL DEVELOPMENT
INTEREST INCOME
INTEREST RATE
LEGAL PROVISIONS
LOAN CLASSIFICATION
LOAN LOSS PROVISIONS
LOSS RATIO
MARKET DISCIPLINE
OPERATING COSTS
OPERATING INCOME
PORTFOLIO
PORTFOLIO DIVERSIFICATION
PORTFOLIOS
PREMIUMS
PRESENT VALUE
PROFIT MAXIMIZATION
PROFITABILITY
PROVISIONING
PRUDENTIAL REGULATIONS
PUBLIC DEBT
PUBLIC FINANCE
PUBLIC OWNERSHIP
RATES
REGULATORY FRAMEWORK
RESERVES
RETAINED EARNINGS
RISK MANAGEMENT
RISK MEASUREMENT
RISK PREMIUM
SHAREHOLDERS
SOLVENCY
SUBSIDIARY
TAX
TAX INCENTIVES
TAX REVENUES
TAXATION
TAXES
TRANSPARENCY
WRITE OFFS
spellingShingle ACCOUNTING PRACTICES
ACCOUNTING PROCEDURES
ACCOUNTING RULES
ACCOUNTING TREATMENT
AGENCY PROBLEMS
ANNUAL ACCOUNTS
ASSETS
ASYMMETRIC INFORMATION
BALANCE SHEET
BALANCE SHEETS
BANK CAPITAL
BANK CAPITAL REGULATION
BANK DEPOSITS
BANK EARNINGS
BANK LENDING
BANK LIQUIDITY
BANK LOANS
BANK REGULATION
BANKING SECTOR
BANKING SUPERVISION
BANKING SYSTEM
BANKS
CAPITAL REGULATION
CAPITAL REQUIREMENT
CAPITAL REQUIREMENTS
COMMERCIAL BANKS
COMPULSORY RESERVES
CONSOLIDATION
COST OF CAPITAL
CREDIT RISK
DEPOSITS
DIVIDEND POLICY
DIVIDENDS
ECONOMETRIC EVIDENCE
ECONOMICS
EXPECTED VALUES
FINANCIAL INSTITUTIONS
FINANCIAL INTERMEDIATION
FINANCIAL REGULATION
FINANCIAL SECTOR
FINANCIAL STABILITY
FISCAL DEFICITS
GDP
GOVERNMENT BONDS
GROWTH RATE
INCOME
INCOME STATEMENTS
INCOME TAXES
INSTITUTIONAL DEVELOPMENT
INTEREST INCOME
INTEREST RATE
LEGAL PROVISIONS
LOAN CLASSIFICATION
LOAN LOSS PROVISIONS
LOSS RATIO
MARKET DISCIPLINE
OPERATING COSTS
OPERATING INCOME
PORTFOLIO
PORTFOLIO DIVERSIFICATION
PORTFOLIOS
PREMIUMS
PRESENT VALUE
PROFIT MAXIMIZATION
PROFITABILITY
PROVISIONING
PRUDENTIAL REGULATIONS
PUBLIC DEBT
PUBLIC FINANCE
PUBLIC OWNERSHIP
RATES
REGULATORY FRAMEWORK
RESERVES
RETAINED EARNINGS
RISK MANAGEMENT
RISK MEASUREMENT
RISK PREMIUM
SHAREHOLDERS
SOLVENCY
SUBSIDIARY
TAX
TAX INCENTIVES
TAX REVENUES
TAXATION
TAXES
TRANSPARENCY
WRITE OFFS
Cavallo, Michele
Majnoni, Giovanni
Do Banks Provision for Bad Loans in Good Times? Empirical Evidence and Policy Implications
relation Policy Research Working Paper;No. 2619
description Recent debate about the pro-cyclical effects of bank capital requirements, has ignored the important role that bank loan loss provisions play in the overall framework of minimum capital regulation. It is frequently observed that under-provisioning, due to inadequate assessment of expected credit losses, aggravates the negative effect of minimum capital requirements during recessions, because capital must absorb both expected, and unexpected losses. Moreover, when expected losses are properly reflected in lending rates, but not in provisioning practices, fluctuations in bank earnings magnify true oscillations in bank profitability. The relative agency problems faced by different stakeholders, may help explain the prevailing, and often unsatisfactory institutional arrangements. The authors test their hypotheses with a sample of 1,176 large commercial banks - 372 of them in non-G10 countries - for the period 1988-99. After controlling for different country-specific macroeconomic, and institutional features, they find robust evidence among G10 banks, of a positive association between loan loss provisions, and banks' pre-provision income. Such evidence is not confirmed for non-G10 banks, which on average, provision too little in good times, and are forced to increase provisions in bad times. The econometric evidence shows that the protection of outsiders' claims - the claims of minority shareholders in common law countries, and of fiscal authorities in countries with high public debt - on bank income, has negative effects on the level of bank provisions.
format Publications & Research :: Policy Research Working Paper
author Cavallo, Michele
Majnoni, Giovanni
author_facet Cavallo, Michele
Majnoni, Giovanni
author_sort Cavallo, Michele
title Do Banks Provision for Bad Loans in Good Times? Empirical Evidence and Policy Implications
title_short Do Banks Provision for Bad Loans in Good Times? Empirical Evidence and Policy Implications
title_full Do Banks Provision for Bad Loans in Good Times? Empirical Evidence and Policy Implications
title_fullStr Do Banks Provision for Bad Loans in Good Times? Empirical Evidence and Policy Implications
title_full_unstemmed Do Banks Provision for Bad Loans in Good Times? Empirical Evidence and Policy Implications
title_sort do banks provision for bad loans in good times? empirical evidence and policy implications
publisher World Bank, Washington, DC
publishDate 2014
url http://documents.worldbank.org/curated/en/2001/06/1490107/banks-provision-bad-loans-good-times-empirical-evidence-policy-implications
http://hdl.handle.net/10986/19607
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