Abstract
This study investigated the evidence of pro-cyclical behaviour of loan loss provision in four East Asian countries, namely Malaysia, Thailand, Singapore, and Hong Kong for the period 1995-2009. Pro-cyclical is defined as building up more loan loss provision during the bad times and reducing them in good times. This study hypothesized that pro-cyclical behaviour of loan loss provision exists in East Asian countries, since they had experienced two types of financial crises – Asian financial crisis in 1997 and global economic crisis in 2008. Utilising a sample of 47 banks, the findings demonstrated that there is evidence of a pro-cyclical pattern in the countries studied, as shown by the negative relationship between loan loss provision and GDP. This study does have a policy implication, where bank regulators should take pro-active action in addressing the issue of pro-cyclicality of loan loss provision because in bad times, increasing loan loss provision would affect the bank’s profit, weaken the bank’s capital, and in turn, diminish its lending activities to creditworthy borrowers. Keywords: Pro-cyclical, Loan loss provision, Malaysian bank
Highlights
Loan loss provision1 are accrual expenses for loan losses and charged on the bank’s income statement as a non-cash expense to absorb any losses arising from loan default by customers
Some argued that lack of definitive standards in recognising loan losses under the Generally Accepted Accounting Principles (GAAP) (Beaver & Engel, 1996; Hasan & Wall, 2004) has given substantial leeway to bank managers to determine the provision for loan losses
Employing a sample of 146 Islamic banks around the world that covered period from 1997 to 2012, the findings indicated that loan loss provisioning in Islamic banks is pro-cyclical, where higher economic growth leads to a decline in loan loss provision
Summary
Loan loss provision are accrual expenses for loan losses and charged on the bank’s income statement as a non-cash expense to absorb any losses arising from loan default by customers. Loan loss provision generally have a direct impact on banks’ earnings and regulatory capital that would affect the shareholders’ returns (Ahmed et al, 1999; Bouvatier & Lepetit, 2008; Hasan & Wall, 2004). Previous literature demonstrated that bank loan loss provisioning is associated with issues of income smoothing, capital management, signalling mechanism, and pro-cyclical behaviour. Among these issues, the pro-cyclical issue has motivated this paper to investigate further since pro-cyclicality is commonly associated with economic condition. This could weaken the bank’s capital, in turn diminishes its lending activities to creditworthy borrowers, and eventually triggers a credit crunch that might worsen the economic depression (Wall & Koch, 2000)
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