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Bank Provisioning Behaviour and Procyclicality

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  • Jacob A. Bikker
  • Paul A.J. Metzemakers

Abstract

The current debate on the possible procyclicality of the new Basel Accord pays little attention to the procyclicality created by unsound loan loss provisioning. This paper investigates how bank provisioning behaviour is related to the business cycle, using 8,000 bank-year observations from 29 OECD countries over the past decade. Provisioning turns out to be substantially higher when GDP growth is lower, reflecting increased riskiness of the credit portfolio when the business cycle turns downwards, which also increases the risk of a credit crunch. This effect is mitigated somewhat as provisions rise in times when earnings are higher, suggesting income smoothing,and loan growth is higher, indicating increased riskiness.

Suggested Citation

  • Jacob A. Bikker & Paul A.J. Metzemakers, 2003. "Bank Provisioning Behaviour and Procyclicality," DNB Staff Reports (discontinued) 111, Netherlands Central Bank.
  • Handle: RePEc:dnb:staffs:111
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    File URL: https://www.dnb.nl/binaries/sr111_tcm46-146888.pdf
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    References listed on IDEAS

    as
    1. Demirguc-Kunt, Asli & Huizinga, Harry, 2000. "Financial structure and bank profitability," Policy Research Working Paper Series 2430, The World Bank.
    2. Laeven, Luc & Majnoni, Giovanni, 2003. "Loan loss provisioning and economic slowdowns: too much, too late?," Journal of Financial Intermediation, Elsevier, vol. 12(2), pages 178-197, April.
    3. Demirguc, Asli & Huizinga, Harry, 1999. "Determinants of Commercial Bank Interest Margins and Profitability: Some International Evidence," World Bank Economic Review, World Bank Group, vol. 13(2), pages 379-408, May.
    4. Robert T. Clair, 1992. "Loan growth and loan quality: some preliminary evidence from Texas banks," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, issue Q III, pages 9-22.
    5. Fudenberg, Drew & Tirole, Jean, 1995. "A Theory of Income and Dividend Smoothing Based on Incumbency Rents," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 75-93, February.
    6. Philip Lowe, 2002. "Credit risk measurement and procyclicality," BIS Working Papers 116, Bank for International Settlements.
    7. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
    8. Bikker, J.A. & Metzemakers, P.A.J., 2005. "Bank provisioning behaviour and procyclicality," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 15(2), pages 141-157, April.
    9. Claudio Borio & Craig Furfine & Philip Lowe, 2001. "Procyclicality of the financial system and financial stability: issues and policy options," BIS Papers chapters,in: Bank for International Settlements (ed.), Marrying the macro- and micro-prudential dimensions of financial stability, volume 1, pages 1-57 Bank for International Settlements.
    10. Kim, Daesik & Santomero, Anthony M., 1993. "Forecasting required loan loss reserves," Journal of Economics and Business, Elsevier, vol. 45(3-4), pages 315-329.
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    12. Carmen M. Reinhart, 2002. "An Introduction," World Bank Economic Review, World Bank Group, vol. 16(2), pages 149-150, August.
    13. Con Keating & Hyun Song Shin & Charles Goodhart & Jon Danielsson, 2001. "An Academic Response to Basel II," FMG Special Papers sp130, Financial Markets Group.
    14. J.A. Bikker & H. Hu, 2003. "Cyclical Patterns in Profits, Provisioning and Lending of Banks," DNB Staff Reports (discontinued) 86, Netherlands Central Bank.
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    More about this item

    Keywords

    banks; loan loss provisioning; lending; credit crunch; business cycle; procyclicality; income smoothing; capital management;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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