Publication: Do Banks Provision for Bad Loans in Good Times? Empirical Evidence and Policy Implications
Date
2001-06
ISSN
Published
2001-06
Author(s)
Cavallo, Michele
Majnoni, Giovanni
Abstract
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.
Link to Data Set
Citation
“Cavallo, Michele; Majnoni, Giovanni. 2001. Do Banks Provision for Bad Loans in Good Times? Empirical Evidence and Policy Implications. Policy Research Working Paper;No. 2619. © World Bank, Washington, DC. http://hdl.handle.net/10986/19607 License: CC BY 3.0 IGO.”
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