Bank loan-loss provisioning, central bank rules vs. estimation: the case of Portugal
Author: Dermine, Jean ; Neto de Carvalho, CristinaINSEAD Area: FinanceIn: Journal of Financial Stability, vol. 4, no. 1, April 2008 Language: EnglishDescription: p. 1-22.Type of document: INSEAD ArticleNote: Please ask us for this itemAbstract: A fair level of provisions on bad and doubtful loans is an essential input in mark-to-market accounting, and in the calculation of bank profitability, capital and solvency. Loan-loss provisioning is directly related to estimates of loan-loss given default (LGD). A literature on LGD on bank loans is developing but, surprisingly, it has not been exploited to address, at the micro level, the issue of provisioning at the time of default, and after the default date. For example, Portugal's central bank imposes a mandatory provisioning schedule based on the time period since a loan is declared 'non-performing'. The dynamic schedule is 'ad hoc', not based on empirical studies. The purpose of the paper is to present an empirical methodology to calculate a fair level of loan-loss provisions, at the time of default and after the default date. To illustrate this a dynamic provisioning schedule is estimated with micro-data provided by a Portuguese bank on recoveries on non-performing loans. This schedule is then compared to the regulatory provisioning schedule imposed by the central bank| Item type | Current location | Call number | Status | Date due | Barcode | Item holds |
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A fair level of provisions on bad and doubtful loans is an essential input in mark-to-market accounting, and in the calculation of bank profitability, capital and solvency. Loan-loss provisioning is directly related to estimates of loan-loss given default (LGD). A literature on LGD on bank loans is developing but, surprisingly, it has not been exploited to address, at the micro level, the issue of provisioning at the time of default, and after the default date. For example, Portugal's central bank imposes a mandatory provisioning schedule based on the time period since a loan is declared 'non-performing'. The dynamic schedule is 'ad hoc', not based on empirical studies. The purpose of the paper is to present an empirical methodology to calculate a fair level of loan-loss provisions, at the time of default and after the default date. To illustrate this a dynamic provisioning schedule is estimated with micro-data provided by a Portuguese bank on recoveries on non-performing loans. This schedule is then compared to the regulatory provisioning schedule imposed by the central bank
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