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Cyclically Adjusted Provisions and Financial Stability

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  • Agénor, Pierre-Richard
  • Pereira da Silva, Luiz A.

Abstract

This paper studies the extent to which alternative loan loss provisioning regimes affect the procyclicality of the financial system and financial stability. It uses a DSGE model with financial frictions (namely, balance sheet and collateral effects, as well as economies of scope in banking) and a generic formulation of provisioning regimes. Numerical experiments with a parameterized version of the model show that cyclically adjusted (or, more commonly called, dynamic) provisioning can be highly effective in terms of mitigating procyclicality and financial instability, measured in terms of the volatility of the credit-output ratio and real house prices, in response to financial shocks. The optimal combination of simple cyclically adjusted provisioning and countercyclical reserve requirements rules is also studied. The simultaneous use of these instruments does not improve the ability of either one of them to mitigate financial instability, making them partial substitutes rather than complements.

Suggested Citation

  • Agénor, Pierre-Richard & Pereira da Silva, Luiz A., 2018. "Cyclically Adjusted Provisions and Financial Stability," IDB Publications (Working Papers) 7619, Inter-American Development Bank.
  • Handle: RePEc:idb:brikps:7619
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    More about this item

    Keywords

    Financial Frictions; Loan Loss Reserves; Financial Systems; Loan loss provisions; Financial Stability;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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