Research On Commercial Bank Dynamic Provisioning

Under current accounting standards (known as the incurred loss model), the methodology to recognize loan losses are event driven and should only be recognized upon an event's occurrence. This has tended to mean that reserves for bank's loan losses need to grow significantly during an economic downturn, a time associated with increased credit impairment and default events. After the Financial crisis,critics of the incurred loss model have pointed to it as one of the causes of the severity of strain many financial institutions experienced in the financial crisis of 2007-2009. As the financial crisis has drawn the attention of regulators and market participants to the severe consequences of pro-cyclicality in the financial system, discussions of international regulatory banking reform included the method of dynamic provisioning as a potential alternative to the incurred loss approach. By allowing earlier detection and coverage of credit losses in loan portfolios, dynamic provisioning enable banks to build up a buffer in good times that can be used in bad times. Their anticyclical nature enhances the resilience of both individual banks and the banking system as a whole. Dynamic provisioning could also be an important prudential tool for regulators.The paper describes how dynamic provisions work in a general framework based on expected losses. As the most valuable example of countercyclical provisioning in the world, the Spanish system is also described in the paper. In the paper,a panel of 8 Chinese commercial banks is used for the period 2003～2009 to determine if banking behaviors,especially induced by the the provisioning system, amplify credit fluctuations. The results show that banking credit has inherent procyclicality, macroeconomic variables are relevant to explain credit fluctuations, but the relationship between the non discretionary component of LLP and credit fluctuations is irrelevant.