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Loan/Loss Provisioning in Emerging Europe: Precautionary or Pro-Cyclical?

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  • John Bonin

    () (Department of Economics, Wesleyan University)

  • Marko Kosak

    () (Faculty of Economics, University of Ljubljana, Ljubljana, Slovenia)

Abstract

The recent global financial crisis has generated considerable interest in reviewing the regulatory environment surrounding the banking sectors in most countries and proposals for changes designed to avoid such a severe outcome in the future. In this paper, we consider a particular aspect relevant to bank regulation, namely, the cyclicality of loan loss provisioning, in a region of emerging market economies. All eleven of the countries in our sample are currently new members of the European Union, the first group entering 2004 and the last country joining in 2013. Our time period from 1997 to 2010 covers roughly one and a half business cycles, starting with the impact of the Russian financial crisis and followed by a rapid growth of bank credit prior to the included global financial crisis. We find that the determinants of loan loss provisioning by banks in the region are similar to those found in the literature for other countries both developed and developing ones. We find evidence on income smoothing through provisioning and capital management by substitution. Unlike the results in much of the literature, we do not find statistically significant evidence of bank-specific pro-cyclicality, i.e., a strong positive relationship between provisioning and individual bank loan growth. However, we do find strong and robust evidence of macroeconomic pro-cyclicality, i.e., a strong positive relationship between provisioning and country GDP growth. Based on the innovative policy of dynamic (statistical) provisioning instrument adopted by Spanish regulators in 2000 to smooth provisioning over the business cycle, we draw implications for regulatory design specific to this region in which financial sectors are bank-centric and financial deepening is occurring.

Suggested Citation

  • 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.
  • Handle: RePEc:wes:weswpa:2013-010
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    File URL: http://repec.wesleyan.edu/pdf/jbonin/2013010_bonin.pdf
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    References listed on IDEAS

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    1. 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.
    2. David Roodman, 2009. "How to do xtabond2: An introduction to difference and system GMM in Stata," Stata Journal, StataCorp LP, vol. 9(1), pages 86-136, March.
    3. 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.
    4. Gabriel Jiménez & Jesús Saurina, 2006. "Credit Cycles, Credit Risk, and Prudential Regulation," International Journal of Central Banking, International Journal of Central Banking, vol. 2(2), May.
    5. Bouvatier, Vincent & Lepetit, Laetitia, 2008. "Banks' procyclical behavior: Does provisioning matter?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 18(5), pages 513-526, December.
    6. 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.
    7. Frank Packer & Haibin Zhu, 2012. "Loan loss provisioning practices of Asian banks," BIS Working Papers 375, Bank for International Settlements.
    8. Vincent Bouvatier & Laetitia Lepetit, 2006. "Banks'procyclicality behavior : does provisioning matter ?," Cahiers de la Maison des Sciences Economiques bla06035, Université Panthéon-Sorbonne (Paris 1).
    9. Foos, Daniel & Norden, Lars & Weber, Martin, 2010. "Loan growth and riskiness of banks," Journal of Banking & Finance, Elsevier, vol. 34(12), pages 2929-2940, December.
    10. Windmeijer, Frank, 2005. "A finite sample correction for the variance of linear efficient two-step GMM estimators," Journal of Econometrics, Elsevier, vol. 126(1), pages 25-51, May.
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    Cited by:

    1. Ozili, Peterson K, 2017. "Bank Loan Loss Provisions Research: A Review," MPRA Paper 76495, University Library of Munich, Germany.
    2. repec:eee:bracre:v:50:y:2018:i:5:p:539-558 is not listed on IDEAS

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