Do Loan Loss Provisions Affect the Credit Fluctuations in China’s Banking System?

ABSTRACT

The global financial crisis of 2008 sparked new ideas on pro-cyclical transmission in the financial system. The accounting treatment method of loan loss provisions differs between the accounting standards that banks use and the supervisory rules of banks. This fundamental difference has attracted wide attention from academics and regulators. This article studies whether bank loan loss provisions affect credit fluctuation in China’s banking system. We divide loan loss provisions into discretionary and non-discretionary loan loss provisions. We find that non-discretionary loan loss provisions result in greater credit fluctuation, whereas discretionary loan loss provisions have no significant impact on credit fluctuation. Further evidence shows that the relation between non-discretionary loan loss provisions and credit fluctuations does not vary among different types of banks. Overall, our study shows that non-discretionary loan loss provisions can increase credit fluctuation and therefore strengthen banks’ pro-cyclical behavior.

KEY WORDS:

• banking in China
• credit fluctuation
• discretionary
• loan loss provisions
• loan loss provisions
• non-discretionary loan loss provisions

JEL Classifications:

• G21

Notes

1. Other authors refer to these banks as “corporatized.” The report uses the term most frequently used in the Chinese literature, “equitized.” These refer to the five banks that were previously wholly state-owned, but later were transformed into join-stock companies, in which Chinese central government is usually the largest stockholder. The five banks are: Agricultural Bank of China, Bank of China, Bank of Communications, China Construction Bank, and Industrial and Commercial Bank of China.

2. Other authors refer to these banks as “local banks.”

3. The three state-owned banks are the Agricultural Development Bank of China (ADBC), the China Development Bank (CDB), and the China Exim Bank (CEB).

4. The five equitized banks are the Agricultural Bank of China (ABC), the Bank of China (BOC), the Bank of Communications, the China Construction Bank (CCB), and the Industrial and Commercial Bank of China (ICBC).

5. In addition to being affected by the financial crisis in 2008.

Additional information

Funding

This research was supported by The National Natural Science Foundation of China [71371194, 71631008].