Addressing the pro-cyclicality of capital requirements with a dynamic loan loss provision system
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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Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers)
- Vincent Bouvatier & Laetitia Lepetit, 2006. "Banks'procyclicality behavior : does provisioning matter ?," Cahiers de la Maison des Sciences Economiques bla06035, Université Panthéon-Sorbonne (Paris 1).
- 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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