Do cyclicality of loan-loss provisions and income smoothing matter for the capital crunch – the case of commercial banks in Poland

This paper examines the impact of bank capital ratios on bank lending by comparing differences in loan growth to differences in capital ratios at sets of banks that are clustered based on loan-loss provisioning practices. Using a hand-collected unique quarterly dataset (of Polish commercial banks) covering the period of 2000 Q1–2012 Q4, we find that loans growth is particularly capital constrained in poorly- -capitalized banks, during both non-recessionary and recessionary periods. Lending of banks with low procyclicality of loan-loss provisions (LLP) is not affected by capital ratio in recessionary periods. Low-procyclicality of LLPs does not make poorly-capitalized banks’ lending immune to recessionary capital crunch. In contrast to the common view, profit stabilizing practices achieved through income smoothing do not make banks’ lending resilient to capital constraints during recession, as we find that high income smoothing banks seem to suffer from increased capital pressures in their lending. This effect is also present in well-capitalized banks. The implication of our research is that decision- -makers implementing new accounting standards for loan-loss allowance (the expected credit loss approach) may not be effective in reducing the procyclicality of capital regulation if they attempt to reduce recessionary capital constraints solely through profit-stabilizing income smoothing.