Determinants of Loan Loss Provisions: The Case of Indian Banks

Rekha Misra, Radheshyam Verma and Samudra Biswas in May 2020 Monthly Bulletin look at how India’s banks make loan provisions:

The paper attempted to examine the impact of both discretionary and non-discretionary factors on loan loss provisioning by Indian banks during 2005-2017. Most of the non-discretionary factors were found to be quite significant in explaining the changes in provisioning while amongst the discretionary factors only income smoothing via loan loss provisioning existed in Indian banks.

Our findings suggest that India’s loan loss provisioning is pro-cyclical which can amplify the business cycles. Moreover, it was found that provisioning by PSBs was more pro-cyclical as compared to PVBs. In this context, the implementation of Indian Accounting Standards (Ind-AS), which requires banks to make provisions for expected credit losses from the time a loan is originated rather than awaiting ‘trigger events’ signalling imminent losses, is expected to help address this issue. Recognising and providing for actual and potential loan losses at an earlier stage in the credit cycle could potentially reduce pro-cyclicality and foster financial stability as Ind-AS requires a dynamic approach to provisioning based on expected credit losses, instead of the current system which is based on days-past-due.

For further research it would be interesting to explore which kind of provisioning practices are more pro-cyclical, i.e., specific or general provisioning as that would give an intuition in terms of the direction that dynamic provisioning should focus on. Additionally, it would be interesting to see whether corporate governance via earnings management is a significant determinant of loan loss provisioning.

 

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