Loan Loss Provisions Of Banks In China: Current Practice And Future Improvement

Loan loss provision is an expense account aside as an allowance for loss loans. It's a preventive measure for loan loss resulted from credit risk. Excess loan loss reserves should be include in the capital in capital adequacy ratio(CAR) computation while inadequate loan loss reserves must be deducted from capital in CAR computation. In conclusion, loan loss provision is not merely an accounting issue, but also a factor influences bank profit and capital.Because of the relationship between loan loss reserve and capital, CBRC, PBOC and China Finance Ministry institute rules to govern and restrict loan loss provision by defining the scope and method to draw provisions. We have a strict regulatory system of loan loss provision. However, regulatory requirements and accounting standards are set up for different purpose and the reform of policies had never been consistent. As a result, internal loan loss provision systems of banks are inconsistent, which reduce the comparability and transparency of financial information.Accounting measurement follows the principle of reliability. China's accounting standards refer to IAS 39 and thus the provision is based on incurred loss model. Banking regulators implement prudential supervision on banking business. Therefore, regulators require provisions adequate to cover all risks including both expected and unexpected loss. Currently, according to PBOC's guidance on loan loss provisions, general loan loss provision is required to cover unexpected loss and special loan loss provision is proportional to loan grading system. CBRC puts restrains on loan loss provision by launching loan provision coverage rate and provision to loss loan ratio. Current provision system enables banks to manipulate net profit and capital using loan loss provision.There are four chapters in this essay. In the first chapter, the author outlines the main topic and methodology of research. The second chapter states the historical policies and accounting standards of loan loss provision and compares the difference between current regulatory policies and accounting standards. Since new accounting standards started to implement in banking industry in 2007, the gaps between PBOC's guidance and accounting standards force banks to measure loan loss provision under different system. The author introduces how she set up regression model to analyze the relationship between current year loan loss provision and several indicators such as profitability ratio, capital ratio and GDP growth rate, etc. Data of banks in China from Year 2007-2012 are selected from Bankscope database and the data are classified into three groups to better understand the situations in listed banks, local-in banks and the rest banks.The author summarizes the findings and compares the differences based on the regression results by groups. In the final part, after analyzing the institutional factors that affect loan loss provision in the third part, the author outlines latest reform in Basel III and IFRS 9 to elaborate the trend in loan loss provision governing policies. Finally, the author gives out her suggestions to better internal current loan loss provision system and opinions about future agreement of regulatory and accounting policies.