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Loan Loss Provisioning Rules, Procyclicality, and Financial Volatility

  • Pierre-Richard Agénor
  • Roy Zilberman

Interactions between loan loss provisioning rules and business cycle fluctuations are studied in a dynamic stochastic general equilibrium model with credit market imperfections. With a backward-looking provisioning system, provisions are triggered by past due payments, which, in turn, depend on current economic conditions and the loan loss reserves-loan ratio. With a forward-looking system, both past due payments and expected losses over the whole business cycle are accounted for, and provisions are smoothed over the cycle. Experiments show that holding more provisions can reduce the procyclicality of the financial system. However, a forward-looking provisioning regime can increase or lower procyclicality, depending on whether holding more loan loss reserves translates into a higher or lower fraction of nonperforming loans. A credit gap-augmented Taylor rule, coupled with a backward-looking provisioning system may be quite effective at mitigating real and financial volatility

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Paper provided by Economics, The Univeristy of Manchester in its series Centre for Growth and Business Cycle Research Discussion Paper Series with number 184.

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Length: 45 pages
Date of creation: 2013
Date of revision:
Handle: RePEc:man:cgbcrp:184
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