Abstract
Dynamic provisions could help to enhance the solvency of individual banks and reduce procyclicality. Accomplishing these objectives depends on country-specific features of the banking system, business practices and the calibration of the dynamic provisions scheme. In the case of Chile, a simulation analysis suggests Spanish dynamic provisions would improve banks’ resilience to adverse shocks but would not reduce procyclicality. To address the latter, other countercyclical measures should be considered.
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REFERENCES AND NOTES
Borio, C., Furfine, C. and Lowe, P. (2001) Procyclicality of the financial system and financial stability: Issues and policy options. In: Marrying the Macro- and Micro- Prudential Dimensions of Financial Stability, BIS Papers No. 1: 1–57, are among the first to discuss the interaction between procyclicality and financial stability. Brunnermeier, M., Crockett, A., Goodhart, C., Persaud, A. and H.-S. Shin (2009) The Fundamental Principles of Financial Regulation. Geneva Report on the World Economy, Vol. 11 provide a more recent discussion building on the experience of the 2008–2009 crisis. Regulatory and accounting practices could contribute to procyclicality: See for instance Gordy, M. and Howells, B. (2006) Procyclicality in Basel II: Can we treat the disease without killing the patient? Journal of Financial Intermediation 15(2): 397–417; and Plantin, G., Sapra, H. and Shin, H. (2008) Marking to market: Panacea or Pandora's Box? Journal of Accounting Research 46(2): 435–460; which may have been further exacerbated by global financial integration, as explained among others by Chan-Lau, J.A. (2008) The globalization of finance and its implications for financial stability: An overview of the issues. International Journal of Banking, Accounting, and Finance 1(1): 3:29.
Dynamic provisions were first introduced in Spain in 2000, see Poveda, R. (2000) La Reforma del Sistema de Provisiones de Insolvencia. Banco de España, Boletín Económico: 73–91 (Enero); and Fernández de Lis, S., Martínez Pagés, J. and Saurina, J. (2000) Credit Growth, Problem Loans and Credit Risk Provisioning in Spain. Banco de España, Documento de Trabajo No. 0018 (Madrid).
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Dynamic provisions are criticized on the basis that income and profit smoothing works against financial statement transparency. See Financial Accounting Standards Board and the International Accounting Standards Board. (2009) Spanish Provisions Under IFRS, Information for Observers. IASB/FASB Meeting, March (London). The Financial Stability Board (FSB), and the Basel Committee on Banking and Supervision (BCBS), the IASB and the US FASB published for public comment a proposed common solution for impairment accounting on 31 January 2011.
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Saurina, J. (2009) Loan loss provisions in Spain. A Working MacroPrudential Tool. Revista de Estabilidad Financiera 17: 9–26, Madrid: Bank of Spain. For a concise description of dynamic provision regimes other than the Spanish one, see Chan-Lau, J.A. (2011) Leaning against the Wind in Latin America: Capital Requirements, Leverage Ratios, Countercyclical Capital Buffers and Dynamic Provisions. Washington DC (mimeo).
Other studies use counterfactual simulation based on historical data to assess the hypothetical performance of provisions under a dynamic provisions. In a counterfactual simulation, the loan and loan losses data are taken as given, and provisions are calculated according to the dynamic provision rule. The counterfactual provision time series under the dynamic provisions rule is then contrasted with the historical provision time series. See for instance Balla, E. and McKenna, A. (2009) Dynamic Provisioning: A Countercyclical Tool for Loan Loss Reserves. Economic Quarterly 95(4): 383–418; Burroni et al4; Fillat, L. and Montoriol-Garriga, J. (2010) Addressing the Pro-Cyclicality of Capital Requirements with a Dynamic Loan Loss Provision System. Federal Reserve Bank of Boston. Working Paper No. QAU10-4; Saurina9; and Wezel, T. (2010) Dynamic Loan Loss Provisions in Uruguay: Properties, Shock Absorption Capacity and Simulations Using Alternative Formulas. Washington DC: International Monetary Fund. Working Paper no. 10/125.
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Besides parameter calibration, the successful implementation of a dynamic provisions scheme requires addressing several issues like the estimation of long-run expected losses and the tax and accounting treatment of reserves. See Mann and Michael.5
Basel Committee on Banking Supervision. (2010a) Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems. Basel and (2010b) Guidance for National Authorities Operating the Countercyclical Capital Buffer. Basel.
Chan-Lau, J.A.9
Acknowledgements
The views in this paper do not necessarily reflect those of the IMF. This article benefits from comments by Jorge Cayazzo, Francesco Columba, Alessandro Giustinianni, Dora Iakova, seminar participants at the Central Bank of Chile, and especially Patricio Jaramillo, David Pacheco and Torsten Wezel. The data was kindly provided by the Superintendencia de Bancos e Instituciones Financieras de Chile. Any errors and omissions are the author's sole responsibility.
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Chan-Lau, J. Do dynamic provisions enhance bank solvency and reduce credit procyclicality? A study of the Chilean Banking system. J Bank Regul 13, 178–188 (2012). https://doi.org/10.1057/jbr.2012.4
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DOI: https://doi.org/10.1057/jbr.2012.4