Improving Loan Loss Provisioning Framework as a Driver of Economic Growth

Abstract

Various aspects of credit risk have been studied by many researchers. Scientists and practitioners consider different credit risk assessment methods depending on its application, e.g. to determine capital adequacy, to make loss loan provisions, or to estimate its influence on the interest rate. At the same time, there are almost no studies that consider the relationship between loan loss provisioning framework and loan decisions. The study seeks to 1) understand how the practices and procedures of loan loss provisioning impact total gross loans of Russian banks, and 2) identify constraints for insufficient levels of lending and factors that can foster lending.
With the use of an econometric model we estimate a quantitative effect of credit portfolio on the growth of loan loss provisions. We base our model on data derived from financial statements of 400 Russian credit institutions between 2014 and 2019. In addition to our empirical model, we analyze statistical data on the development of the Russian banking system and compare the loan loss provisions in Russian and foreign financial organizations. The estimates are based on Russian official statistics and financial statements of banks within and outside Russia. The study reveals that the existing credit risk assessment method that rests on the regulations provided by the Bank of Russia is responsible for excessive loan loss provisions accumulated by Russian banks. This, in turn, affects the volumes of bank loans.
In our research we have arrived at the conclusion that the existing loan loss provisioning is excessive. Current loan loss provisions do not correspond to real lending losses. They negatively affect the financial results of credit institutions, resulting in ungrounded refusals to lend, which in turn limits economic growth. These results support the rationale for reinventing the existing framework of loan loss provisioning.