Credit Quality, Bank Provisioning and Systematic Risk in Banking Business

Abstract

Based on a sample of 59 European banks over the period 2006-2011, we investigate the impact of the loan loss provisioning (LLP) together with a wide array of credit-risk exposure and performance variables on systematic risk measured by betas. We develop a model for assessing whether management behaviour, accounting policies, such as LLP, and the quality of loan portfolio play a significant role in explaining the banks' systematic risk exposure. Our results suggest that financial performances do not have a direct significant relation with betas; rather measures of risk exposures (risk weighted assets on total assets) substantially affect systematic risk. During crisis systematic risk significantly responsive to provisions and their impacts on performances. Our study has several implications, in particular at light of changing European regulation on non-performing exposures reporting and forbearance practices alongside with regulators forcing banks to strengthen their capital base.