The procyclicality of loan loss provisions in Islamic banks

Wahyoe Soedarmono, Sigid Eko Pramono and Amine Tarazi
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Sigid Eko Pramono: bank indonesia - bank indonesia

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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 sufficient bank capitalization.

Keywords: Islamic banks; loan loss provisions; capital management; procyclicality (search for similar items in EconPapers)
Date: 2016-05-20
New Economics Papers: this item is included in nep-sea
Note: View the original document on HAL open archive server: https://unilim.hal.science/hal-01319043v1
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Citations: View citations in EconPapers (4)

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Related works:
Journal Article: The procyclicality of loan loss provisions in Islamic banks (2017)
Working Paper: The procyclicality of loan loss provisions in Islamic banks (2017)
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