Bank provisioning behaviour and procyclicality

The current debate on the possible procyclicality of the new Basel Accord pays little attention to the procyclicality created by unsound loan loss provisioning. This article investigates how bank provisioning behaviour is related to the business cycle, using 8000 bank-year observations from 29 OECD countries over the past decade. Provisioning turns out to be substantially higher when GDP growth is lower, reflecting increased riskiness of the credit portfolio when the business cycle turns downwards, which also increases the risk of a credit crunch. This effect is mitigated somewhat as provisions rise in times when earnings are higher, suggesting income smoothing, and loan growth is higher, indicating increased riskiness.