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Dynamic provisioning: a countercyclical tool for loan loss reserves

  • Eliana Balla
  • Andrew McKenna
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    In the wake of the financial crisis of 2007-2009, as various banking policymakers revisit loan loss provisioning rules, the Spanish approach of dynamic provisioning has garnered attention as a potential alternative to the current incurred loss approach. We review the current approach to loan loss reserves in the United States, focusing on how loan loss reserves relate to bank solvency and why the current accounting approach may have procyclical effects. We present a conceptual framework to compare loan loss provisioning under the incurred loss framework and dynamic provisioning. Then we simulate dynamic provisioning with U.S. data to present an empirical comparison.

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    File URL: http://www.richmondfed.org/publications/research/economic_quarterly/2009/fall/pdf/balla.pdf
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    Article provided by Federal Reserve Bank of Richmond in its journal Economic Quarterly.

    Volume (Year): (2009)
    Issue (Month): Fall ()
    Pages: 383-418

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    Handle: RePEc:fip:fedreq:y:2009:i:fall:p:383-418:n:v.95no.4
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    1. Peek, Joe & Rosengren, Eric, 1995. "The Capital Crunch: Neither a Borrower nor a Lender Be," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(3), pages 625-38, August.
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    3. Ben S. Bernanke & Cara S. Lown, 1991. "The Credit Crunch," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 22(2), pages 205-248.
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    7. John R. Walter, 1991. "Loan loss reserves," Economic Review, Federal Reserve Bank of Richmond, issue Jul, pages 20-30.
    8. Luc Laeven & Giovanni Majnoni, 2002. "Loan loss provisioning and economic slowdowns: too much too late?," Conference Series ; [Proceedings], Federal Reserve Bank of Boston.
    9. Ahmed, Anwer S. & Takeda, Carolyn & Thomas, Shawn, 1999. "Bank loan loss provisions: a reexamination of capital management, earnings management and signaling effects," Journal of Accounting and Economics, Elsevier, vol. 28(1), pages 1-25, November.
    10. Vincent Bouvatier & Laetitia Lepetit, 2006. "Banks' procyclicality behavior : does provisioning matter ?," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00115622, HAL.
    11. George J. Benston & Larry D. Wall, 2005. "How should banks account for loan losses?," Economic Review, Federal Reserve Bank of Atlanta, issue Q4, pages 19-38.
    12. Allen N. Berger & Gregory F. Udell, 2003. "The institutional memory hypothesis and the procyclicality of bank lending behaviour," BIS Working Papers 125, Bank for International Settlements.
    13. Larry D. Wall & Timothy W. Koch, 2000. "Bank loan-loss accounting: a review of theoretical and empirical evidence," Economic Review, Federal Reserve Bank of Atlanta, issue Q2, pages 1-20.
    14. Pennacchi, George G., 2005. "Risk-based capital standards, deposit insurance, and procyclicality," Journal of Financial Intermediation, Elsevier, vol. 14(4), pages 432-465, October.
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