The procyclicality of loan loss provisions in Islamic banks

Wahyoe Soedarmono, Sigid Eko Pramono and Amine Tarazi

Research in International Business and Finance, 2017, vol. 39, issue PB, 911-919

Abstract: From a sample of Islamic banks around the world from 1997 to 2012, this paper examines whether loan loss provisioning in Islamic banks is procyclical. Our empirical findings highlight that loan loss provisioning in Islamic banks remains procyclical, although the ‘expected’ loan loss model (E-LLM) has been implemented for Islamic banks in several countries. A closer investigation further documents that Islamic banks also use loan loss provisions for discretionary managerial actions, especially related to capital management in which loan loss reserves and provisions are inflated when bank capitalization declines. Eventually, this paper highlights that higher capitalization can mitigate the procyclicality of loan loss provisions in Islamic banks. In other words, loan loss provisioning becomes countercyclical for Islamic banks with higher capitalization. This paper therefore casts doubts on the adoption of the E-LLM for Islamic banks to promote countercyclical effects, because the E-LLM may be influenced by managerial discretion, including opportunistic capital management using loan loss provisions that may undermine the importance of maintaining bank capitalization.

Keywords: Islamic banks; Loan loss provisions; Capital management; Procyclicality (search for similar items in EconPapers)
JEL-codes: G21 G28 M41 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

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Working Paper: The procyclicality of loan loss provisions in Islamic banks (2017)
Working Paper: The procyclicality of loan loss provisions in Islamic banks (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:riibaf:v:39:y:2017:i:pb:p:911-919

DOI: 10.1016/j.ribaf.2016.05.003

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