{"id":12329,"date":"2010-09-23T20:56:25","date_gmt":"2010-09-24T00:56:25","guid":{"rendered":"http:\/\/www.prefblog.com\/?p=12329"},"modified":"2010-09-23T20:56:25","modified_gmt":"2010-09-24T00:56:25","slug":"frbb-looks-at-dynamic-provisioning","status":"publish","type":"post","link":"https:\/\/prefblog.com\/?p=12329","title":{"rendered":"FRBB Looks at Dynamic Provisioning"},"content":{"rendered":"

The Federal Reserve Bank of Boston has released<\/a> Working Paper No. QAU10-4 by Jos\u00e9 L. Fillat and Judit Montoriol-Garriga titled Addressing the pro-cyclicality of capital requirements with a dynamic loan loss provision system<\/a>:<\/p>\n

The pro-cyclical effect of bank capital requirements has attracted much attention in the post-crisis discussion of how to make the financial system more stable. This paper investigates and calibrates a dynamic provision as an instrument for addressing pro-cyclicality. The model for the dynamic provision is adopted from the Spanish banking regulatory system. We argue that, had U.S. banks set aside general provisions in positive states of the economy, they would have been in a better position to absorb their portfolios\u2019 loan losses during the recent financial turmoil. The allowances accumulated by means of the hypothetical dynamic provision during the cyclical upswing would have reduced by half the amount of TARP funds required. However, the cyclical buffer for the aggregate U.S. banking system would have been depleted by the first quarter of 2009, which suggests that the proposed provisioning model for expected losses might not entirely solve situations as severe as the one experienced in recent years.<\/p><\/blockquote>\n

This is a useful, if not particularly earth-shattering, paper. If the banks had held more reserves prior to the crisis, they would have had more reserves during the crisis. So?<\/p>\n

What I found interesting was the discussion of Citibank:<\/p>\n

Figure 8, shows that Citibank would have depleted the newly created general allowance in the fourth quarter of 2007\u2014much earlier than the rest of the institutions and earlier than the aggregate of the U.S. financial system. From that date on, Citibank would have been in the same situation as without the dynamic provision. That is, total provisions for loan losses would be equal to the specific allowance (ALLL) during the last 2 years, as observed. The results are driven by a relatively poor performance of the Citibank loan portfolio during the 2000 to 2005 period. During this period, the ratio of specific provisions to loans is above the banking system long-run average. Citibank would have started to build up the stock of reserves in 2006, too late to serve the purpose of attenuating the problems caused by increased loan losses in Citibank\u2019s books with the recession.<\/p><\/blockquote>\n

The figures below show the general allowance, the specific allowance and the total:<\/p>\n

The dynamic provisioning system attempts to create an a-cyclical loan loss provision that reduces the chances of the amplification of an economic crisis through the banking sector. We follow the same approach and calibrate the parameters of the Spanish dynamic provision for the U.S. banking system using publicly available data. We show that if U.S. banks had funded provisions in expansion periods using this provisioning model, they would have been in a better position to absorb loan portfolio losses during the financial turmoil.<\/p><\/blockquote>\n

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Click for Big<\/i><\/p>\n

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Click for Big<\/i><\/p>\n

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Click for Big<\/i><\/div>\n

One thing that makes Dynamic Provisioning important is that it truly is a buffer. After all, if the minimum capital requirement is 4% and you have 5% … then your effective room isn’t really 5%, is it? If you fall below 4% the regulators will sieze your bank and either liquidate or sell it, so your room for mistakes is only 1%. This was the major problem during the crisis – not that capital would fall below 0% – insolvency – but that it would fall below 4% – regulatory siezure.<\/p>\n

One thing I would like to see addressed in future papers on this topic is an analysis of how JPM and BAC would have reacted to the dynamic provisioning requirements estimated here. After all, the proposed rules are not truly countercyclical unless they actually reduce lending during boom times.<\/p>\n","protected":false},"excerpt":{"rendered":"

The Federal Reserve Bank of Boston has released Working Paper No. QAU10-4 by Jos\u00e9 L. Fillat and Judit Montoriol-Garriga titled Addressing the pro-cyclicality of capital requirements with a dynamic loan loss provision system: The pro-cyclical …<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[12],"tags":[],"class_list":["post-12329","post","type-post","status-publish","format-standard","hentry","category-interesting-external-papers"],"_links":{"self":[{"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/posts\/12329","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=12329"}],"version-history":[{"count":0,"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/posts\/12329\/revisions"}],"wp:attachment":[{"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=12329"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=12329"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=12329"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}