| The main purpose of loan loss provision of financial institutions is toprevent significant losses that may occur in the future. If financialinstitutions underestimate credit risk and lower loan loss provision duringeconomic upturn, it is likely the capital adequacy ratio will be overcalculated as they undervalue loan cost or overvalues profit, which leads toincreases in loanable funds, and vise verse during economic downturn. Asthe result, inadequate provision funds would add to economic fluctuation.In this financial crisis, Spanish banks were less impacted compare to others.As we pay closer attention to it, we could discover Spanish banks increaseloan loss provision during economic upturn, and decrease it during downturn.In other words, Spanish banks implemented dynamic loan loss provisionsystem. Experts believe that is the main reason why Spanish banks can stillperform well during the financial crisis.In order to eliminate the negative impact over economy by insufficientloan loss provision, some experts proposed South Korea also needs this kindof dynamic loan loss provision system。To implement dynamic loan loss provision system, three conditionsmust be met: First, financial institutes‘nonperformance loan ratios increaseas loans increase after a period of time. This logic implies loan lossprovision should increase during economic upturn where loans are increasing. Second, where does not comply with the above logic, financialinstitutes‘often lower loan loss provision during economic downturn andincrease it during economic upturn. Third, the dynamic loan loss provisionthat accounted into financial report should comply with current accountingstandard.The research investigates banks with operation during year2000to year2008and insurance companies with debts account more than10%of totalasset, as if they satisfy first and second condition to implement dynamic loanloss provision system.First, the paper will conduct a correlation analysis between loan growthrate and nonperformance loan ratio. In addition, the nonperformance loanratio will also been deemed as an explanatory variable for regressionanalysis.Second, generally speaking during economic upturn where GDP is onrising, at the same time, EBTP(Earning Before Tax and Provision) to totalasset ratio also is on rising. Correlation analyses have been conductedbetween GDP growth rate and the loan loss provision ratio, as well asEBTP/TA and loan loss provision. The loan loss provision ratio also beentreated as an explanatory variable to conduct a regression analysis.The research result demonstrates for banks, the loan growth rate showsa positive correlation with nonperformance loan ratio with two to three yearslate, it satisfy the first condition; the GDP growth rate and loan lossprovision show a negative correlation, it then satisfy the second condition.However, the correlation between EBTP/TA and provision funds is not clear.For insurance companies, the growth loan rate and nonperformanceloan ratio show a positive correlation, which satisfy the first condition;however a position correlation has resulted from the GDP growth rate and the loan loss provision, which fall to meet the second condition. EBTP/TAand the loan loss provisions here show a positive correlation.In order to understand if financial institutes meet all three conditions toimplement the dynamic loan loss provision system, I compared theviewpoints from financial regulatory institutions and the accountingregulatory bodies, as well as the changing attitude of the accountingregulatory bodies after the financial crisis. Through the analysis, we discoverthe current loan accounting standard, IAS39, is allowing the predicted lossof loan packages to account into the expanse after statistical analysis.The research has reached two conclusions: first, banks do satisfy thefirst and second condition, where dynamic loan loss provision system isnecessary. Second, insurance companies only satisfy first condition butsecond one, which the system is not needed. |
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