Addressing the pro-cyclicality of capital requirements with a dynamic loan loss provision system

Jose Fillat and Judit Montoriol-Garriga
Authors registered in the RePEc Author Service: Judit Montoriol Garriga ()

No QAU10-4, Supervisory Research and Analysis Working Papers from Federal Reserve Bank of Boston

Abstract: The pro-cyclical effect of bank capital requirements has attracted much attention in the post-crisis discussion of how to make the financial system more stable. This paper investigates and calibrates a dynamic provision as an instrument for addressing pro-cyclicality. The model for the dynamic provision is adopted from the Spanish banking regulatory system. We argue that, had U.S. banks set aside general provisions in positive states of the economy, they would have been in a better position to absorb their portfolios? loan losses during the recent financial turmoil. The allowances accumulated by means of the hypothetical dynamic provision during the cyclical upswing would have reduced by half the amount of TARP funds required. However, the cyclical buffer for the aggregate U.S. banking system would have been depleted by the first quarter of 2009, which suggests that the proposed provisioning model for expected losses might not entirely solve situations as severe as the one experienced in recent years.

Keywords: Bank capital; Troubled Asset Relief Program (search for similar items in EconPapers)
Date: 2010
New Economics Papers: this item is included in nep-ban
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Citations: View citations in EconPapers (28)

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