Loan Loss Provisions and Lending Behaviour of Banks: Asian Evidence During 1992-2009

Abstract

Effects of loan loss provisioning on lending behaviour of banks remain a major concern in policy circles in order to strengthen both bank stability and financial intermediation. From a sample of commercial banks in Asian countries over the 1992-2009 period, this paper attempts to identify factors contributing to the occurrence of a procyclical effect of loan loss provisions on loan growth in banking by differentiating loan loss provisions into discretionary and non-discretionary provisions. Our empirical results highlight that non-discretionary provisions have indeed a procyclical effect, as higher non-discretionary provisions reduce loan growth of banks. This procyclical effect holds in large banks but disappears in small banks. A closer investigation shows that bank market structure, economic development and institutional quality also affect the link between non-discretionary provisions and loan growth of banks. More specifically, higher bank competition, higher per capita income and higher rule of law mitigate the procyclical effect of non-discretionary provisions on loan growth in banking regardless of whether banks are large or small. These findings have therefore policy implications with regard to the adoption of the dynamic provisioning system for Asian banks.