Procyclicality in Loan Loss Provisions: A Comparative Analysis of Discretionary and Non-Discretionary Components

Abstract

This study investigates the procyclicality of loan loss provision (LLP), with a focus on differentiating the procyclical inclinations of non-discretionary and discretionary components. Using a dataset of 377 IFRS-compliant banks from 75 countries around the world, we analyze how each component of LLP responds to economic cycles during the period from 2013 to 2022. Our findings indicate that non-discretionary LLP exhibits procyclicality, as they respond to observable credit losses that typically rise following economic downturns. Conversely, discretionary LLP, which reflects anticipatory adjustments made by banks in response to economic conditions, does not show procyclicality. These results underscore the role of LLP components in amplifying economic cycles. This research contributes to the broader understanding of procyclicality and financial stability, providing insights for standard setters and policymakers seeking to mitigate the procyclical effects of provisioning practices.