REGULATORY PROVISIONING REQUIREMENTS
Provisions for credit losses are inextricably tied up with regulatory capital requirements and this is acknowledged, to an extent, by the Basel Accord which allows certain provisions to be counted towards regulatory capital. In practice regulators fall into one of two camps, those that put the prime responsibility onto bank management for provisioning and where bank’s behavior is determined by a combination of market forces and moral suasion and those that impose a formulaic-based framework:
Laissez faire. Most regulators in developed markets leave provisioning policies up to individual banks’ management to act within the constraints of local accounting standards and influenced by tax considerations. This does not imply that regulators are disinterested in bank provisioning levels but that they believe that the disadvantages of a formal framework out- weigh any benefits. Where many banks have an exposure to a single counterparty (whether a company, public sector organization or sovereign) provision levels are effectively set by market forces. It would be very difficult for one bank to justify having a significantly lower level of provisioning than others in such cases. Regulators are also likely to act by having a quiet word with management at banks where they are concerned that a particular bank is underprovided. Formulaic. Formulaic provisioning requirements are common in developing markets. Most of these are based in one way or another on the following:
Local problem loan and NPL classifications, e.g. substandard, doubtful, loss.
Age, since problem loans or NPLs were classified as impaired or past-due, e.g. 90 days
past-due, 180 days past-due, one-year past-due.
Level of collateral cover.
General provisions that are not allocated to any particular group of exposures.
General provisions for specific pooled exposures.