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Dynamic provisioning: a countercyclical tool for loan loss reserves

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  • Eliana Balla
  • Andrew McKenna

Abstract

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.

Suggested Citation

  • Eliana Balla & Andrew McKenna, 2009. "Dynamic provisioning: a countercyclical tool for loan loss reserves," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 383-418.
  • Handle: RePEc:fip:fedreq:y:2009:i:fall:p:383-418:n:v.95no.4
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    References listed on IDEAS

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    6. Allen N. Berger, 2003. "The institutional memory hypothesis and the procyclicality on bank lending behavior," Proceedings 845, Federal Reserve Bank of Chicago.
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    8. 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.
    9. Berger, Allen N. & Udell, Gregory F., 2004. "The institutional memory hypothesis and the procyclicality of bank lending behavior," Journal of Financial Intermediation, Elsevier, vol. 13(4), pages 458-495, October.
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    Cited by:

    1. repec:eee:finsta:v:30:y:2017:i:c:p:177-180 is not listed on IDEAS
    2. John Bonin & Marko Kosak, 2013. "Loan/Loss Provisioning in Emerging Europe: Precautionary or Pro-Cyclical?," Wesleyan Economics Working Papers 2013-010, Wesleyan University, Department of Economics.
    3. International Monetary Fund, 2011. "Chile: Selected Issues," IMF Staff Country Reports 11/262, International Monetary Fund.
    4. Dahl, Drew, 2013. "Bank audit practices and loan loss provisioning," Journal of Banking & Finance, Elsevier, vol. 37(9), pages 3577-3584.
    5. Vasiliki Makri, 2016. "Towards an Investigation of Credit Risk Determinants in Eurozone Countries," Journal of Accounting and Management Information Systems, Faculty of Accounting and Management Information Systems, The Bucharest University of Economic Studies, vol. 15(1), pages 27-57, March.
    6. Vasiliki MAKRI & Konstantinos PAPADATOS, 2016. "Determinants Of Loan Quality: Lessons From Greek Cooperative Banks," Review of Economic and Business Studies, Alexandru Ioan Cuza University, Faculty of Economics and Business Administration, issue 17, pages 115-140, June.
    7. Stefano Puddu, 2013. "Optimal Weights and Stress Banking Indexes," IRENE Working Papers 13-02, IRENE Institute of Economic Research.
    8. Ali, Ashraf & M. Kabir, Hassan & Syed Abul, Basher, 2015. "Loan Loss Provisioning in OIC Countries: Evidence from Conventional vs. Islamic Banks," MPRA Paper 61687, University Library of Munich, Germany.
    9. repec:fip:fedcwp:13-13 is not listed on IDEAS
    10. Gabriel Aparici & Fernando Sepúlveda, 2010. "Household Credit Markets During the Financial Crisis of 2008/2009," Working Papers Central Bank of Chile 591, Central Bank of Chile.
    11. repec:kap:jfsres:v:52:y:2017:i:3:d:10.1007_s10693-016-0255-0 is not listed on IDEAS
    12. 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.
    13. Loveland, Robert, 2016. "How prompt was regulatory corrective action during the financial crisis?," Journal of Financial Stability, Elsevier, vol. 25(C), pages 16-36.
    14. Vasiliki Makri, 2015. "What Triggers Loan Losses? An Empirical Investigation of Greek Financial Sector," SPOUDAI Journal of Economics and Business, SPOUDAI Journal of Economics and Business, University of Piraeus, vol. 65(3-4), pages 119-143, july-Dece.

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    Loans;

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