Procyclicality of the Financial Systems in Emerging Economies

Abstract

This research aimed at examining the procyclicality of financial systems in emerging economies, with a particular focus on the role of loan loss provisions. In total, 318 articles were initially retrieved, which after applying the inclusion and exclusion criteria, led to final selection of 15 relevant and latest articles. From the literature reviews, it was found that financial systems in emerging economies exhibit procyclicality behaviour, corresponding to economic cycles. Loan loss provisions, as a key component of bank financial statements, play a significant role in the procyclicality of lending activity. Studies from various countries, including African economies, Jordan, South Africa, Kenya, and the Gulf Cooperation Council (GCC) countries, reveal both pro- and counter-cyclical patterns of loan loss provisions. The degree of procyclicality is influenced by factors such as bank capitalization, bank size, competition, business cycles, macroprudential policies, and the regulatory and supervisory framework. Notably, the findings suggest that policy makers and banking authorities need to address the procyclicality of loan loss provisions and implement effective macroprudential policies to mitigate the impact of economic cycles on lending activities. The study recommends that financial institutions should develop robust risk management practices to better manage economic fluctuations and reduce the impact of procyclicality.