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Addressing the pro-cyclicality of capital requirements with a dynamic loan loss provision system

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  • José L. Fillat
  • Judit Montoriol-Garriga

Abstract

The pro-cyclical effect of bank capital requirements has attracted much attention in the post-crisis discussion of how to make the financial system more stable. This paper investigates and calibrates a dynamic provision as an instrument for addressing pro-cyclicality. The model for the dynamic provision is adopted from the Spanish banking regulatory system. We argue that, had U.S. banks set aside general provisions in positive states of the economy, they would have been in a better position to absorb their portfolios’ loan losses during the recent financial turmoil. The allowances accumulated by means of the hypothetical dynamic provision during the cyclical upswing would have reduced by half the amount of TARP funds required. However, the cyclical buffer for the aggregate U.S. banking system would have been depleted by the first quarter of 2009, which suggests that the proposed provisioning model for expected losses might not entirely solve situations as severe as the one experienced in recent years.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Boston in its series Risk and Policy Analysis Unit Working Paper with number QAU10-4.

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Date of creation: 2010
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Handle: RePEc:fip:fedbqu:qau10-4

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Keywords: Bank capital ; Troubled Asset Relief Program;

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References

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  1. Alvarez, Fernando & Jermann, Urban J., 2000. "Using Asset Prices to Measure the Cost of Business Cycles," Working Papers 00-1, University of Pennsylvania, Wharton School, Weiss Center.
  2. Rafael Repullo & Javier Suarez, 2013. "The Procyclical Effects of Bank Capital Regulation," Review of Financial Studies, Society for Financial Studies, vol. 26(2), pages 452-490.
  3. Vincent Bouvatier & Laetitia Lepetit, 2006. "Banks'procyclicality behavior : does provisioning matter ?," Cahiers de la Maison des Sciences Economiques bla06035, Université Panthéon-Sorbonne (Paris 1).
  4. Glenn Hoggarth & Ricardo Reis & Victoria Saporta, 2001. "Costs of banking system instability: some empirical evidence," Bank of England working papers 144, Bank of England.
  5. Lown, Cara & Morgan, Donald P., 2006. "The Credit Cycle and the Business Cycle: New Findings Using the Loan Officer Opinion Survey," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(6), pages 1575-1597, September.
  6. Mathias Drehmann & Claudio Borio & Leonardo Gambacorta & Gabriel Jiminez & Carlos Trucharte, 2010. "Countercyclical capital buffers: exploring options," BIS Working Papers 317, Bank for International Settlements.
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Citations

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Cited by:
  1. Jorge A. Chan-Lau, 2012. "Do Dynamic Provisions Enhance Bank Solvency and Reduce Credit Procyclicality? a Study of the Chilean Banking System," IMF Working Papers 12/124, International Monetary Fund.
  2. Gabriel Jiménez & Steven Ongena & José-Luis Peydró & Jesús Saurina, 2012. "Macroprudential Policy, Countercyclical Bank Capital Buffers and Credit Supply: Evidence from the Spanish Dynamic Provisioning Experiments," Working Papers 628, Barcelona Graduate School of Economics.
  3. repec:fip:fedcwp:13-13 is not listed on IDEAS
  4. Rafael Repullo & Jesús Saurina, 2011. "The Countercyclical Capital Buffer Of Basel Iii: A Critical Assessment," Working Papers wp2011_1102, CEMFI.
  5. International Monetary Fund, 2012. "Dynamic Loan Loss Provisioning," IMF Working Papers 12/110, International Monetary Fund.
  6. Lakshmi Balasubramanyan & James B Thomson & Saeed Zaman, 2013. "Are banks forward-looking in their loan loss provisioning? Evidence from the Senior Loan Officer Opinion Survey (SLOOS)," Working Paper 1313, Federal Reserve Bank of Cleveland.

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