Do Banks Provision for Bad Loans in Good Times? Empirical Evidence and Policy Implications
Recent debate about the pro-cyclical effects of bank capital requirements has ignored the important role that bank loan loss provisions play in the overall framework of minimum capital regulation. It is frequently observed that under provisioning, due to inadequate assessment of expected credit losses, aggravates the negative effect of minimum capital requirements during recessions because capital must absorb both expected and unexpected losses. Moreover, when expected losses are properly reflected in lending rates but not in provisioning practices, fluctuations in bank earnings magnify true oscillations in bank profitability.