China's Commercial Bank Loan Loss Provisions Pro-cyclical And Credit Fluctuation Effect Test

The global financial crisis has triggered a new round of thinking about the procyclicality of the financial system, and the procyclicality resulting from regulatory requirements re-enters the field of view of researchers and policy makers. To study the counter-cyclical tools under the framework of macro-prudential supervision is particularly important. Loan loss provision as a barrier for commercial banks to prevent the expected risk is extracted from the profits or income, which is mainly used to make up for the expected losses. In theory, loan loss provision allows earlier recognition of loan loss, so it is an important risk prevention tool. During the boom years, if a bank is expected to have more losses, it can provision more. But in reality, due to the Incurred-Loss model of the accounting standards, loan loss provision may be pro-cyclical and pose a negative impact on the economy, which means banks may provision much less in times of economic prosperity, resulting in insufficient to cover losses in an economic downturn, and affect the real economy through various channels, further enlarging the cyclical fluctuations. At the operational level, the dynamic provisioning system has been introduced as a counter-cyclical tool. Under the system, bank’s provision is considered "counter-cyclical", meaning more provision during economic prosperity, and less provision during recession, and eases the cyclical effect under the backward-looking provision.Based on other scholars’findings, this paper uses balanced panel data of China’s commercial banks during2004-2010and system GMM estimation, and empirically analyses the procyclicality of loan loss provisions of China’s commercial banks and other determinants. Combined with macroeconomic factors, the bank level factors and asset price factors, we further analyze whether backward-looking provision amplifies credit fluctuations. Besides, a comparative study of the current dynamic provision practices of the major countries is made. The results show that Chinese commercial bank loan loss provisions, non-discretionary component has a strong pro-cyclical provision acts, any components of the income-smoothing motive, Capital Management, motivation and financial signals the release of the motivation was not significant; pro-cyclical loan loss provisions enlarge the fluctuations of credit supply.