A look at dynamic provisioning in Spanish Banks

World Bank has started releasing short research notes on various policy issues in this crisis. Its 7th note in the series is on Dynamic Provisioning System at Spanish Banks.

Spain developed this much discussed provision tool which was counter-cyclical in nature. It was a system which meant banks provisions increased in good times and declined in bad times. So, as this crisis struck the interesting q was what happened in Spain? Did the new tool help its banks? Was its banking system safe?

This note begins with explaining the dynamic provision system.  Has it helped in this crisis? The note says:


They account on average for about 10 percent of the net operating income of banks. That is why bankers initially were not in favor of dynamic provisions. At the end of 2007 the total accumulated provisions (close to 75  percent were general provisions) covered 1.3 percent of the total consolidated assets of Spanish deposit institutions, at a time that capital and reserves represented 5.8 percent of those assets.

Spanish banks had accumulated a significant buffer to cover incurred losses, a buffer that they have now started to draw down as individual loan losses have begun to mount in parallel with the deterioration in the economy. The buffer was never intended to be permanent. Instead, it is meant to be used in periods such as the current one, when problem loans and specific provisions are surging. By being drawn down, dynamic provisions fulfill their anticyclical purpose.

There is no guarantee, given the depth of the current crisis, that the amounts provisioned will be enough to cover the loan losses that banks are facing. Nevertheless, dynamic provisions have contributed to the stability of the Spanish financial system and allowed Spanish banks to deal with the crisis from a much better starting point.

It does not explain in details but says it worked. What is also interesting is the point that banks resisted this move but has helped them in the end.

On reading the document, I recalled RBI also raised provisions in its Annual Monetary Policy Statement 2006-07. It increased provision and risk weights for real estate loans:

 185. The Committee on Banking Sector Reforms (Chairman: ShriM. Narasimham) had recommended that, as a prudential measure, a general provision of about one per cent of standard assets of banks would be appropriate and should be implemented in a phased manner. The Mid-term Review of October 2005 increased the provisioning requirement on standard assets, with the exception of direct advances to agricultural and SME sectors, from 0.25 per cent to 0.40 per cent of the funded outstanding on portfolio basis. To ensure that asset quality is maintained in the light of high credit growth, it is proposed:

• to increase the general provisioning requirement on standard advances in specific sectors, i.e., personal loans, loans and advances qualifying as capital market exposures, residential housing loans beyond Rs.20 lakh and commercial real estate loans from the present level of 0.40 per cent to 1.0 per cent. As hitherto, these provisions would be eligible for inclusion in Tier II capital for capital adequacy purposes up to the permitted extent.

Operational guidelines in this regard would be issued separately.


(l) Risk Weight on Exposures to Commercial Real Estate


186. In July 2005, the Reserve Bank had increased the risk weight on exposures to commercial real estate from 100 per cent to 125 per cent. Given the continued rapid expansion in credit to this sensitive sector, it is proposed:

• to increase the risk weight to 150 per cent.

This was also not liked by the banking industry then. However, bankers ended praising  Dr Reddy as global crisis hit Indian economy.

Again the issue is not about having more counter-cyclical capital regulations as is being said now. Infact, I have read numerous papers on how the current banking capital system is pro-cyclical and could cause much damage. However, it didn’t move much beyond writing academic papers and discussions. As the crisis hit we again see the same suggestions of reducing procyclicality, macroprudential supervision etc etc.

The real lesson is not having more of these but how do we push these countercyclical capital regulations in good times? How do central bankers/ financial market regulators ignore the banks resistance/criticism to pass such measures? This to me is the real challenge- getting people who want to regulate.  


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