Reserve Requirements and Loan Loss Provisions as Countercyclical Macroprudential Instruments: A Perspective from Latin America

Abstract

work is licensed under a Creative Commons IGO 3.0 AttributionNonCommercial-NoDerivatives (CC-IGO BY-NC-ND 3.0 IGO) license (http://creativecommons.org/licenses/by-nc-nd/3.0/igo/ legalcode) and may be reproduced with attribution to the IDB and for any non-commercial purpose. No derivative work is allowed.Any dispute related to the use of the works of the IDB that cannot be settled amicably shall be submitted to arbitration pursuant to the UNCITRAL rules. The use of the IDB's name for any purpose other than for attribution, and the use of IDB's logo shall be subject to a separate written license agreement between the IDB and the user and is not authorized as part of this CC-IGO license.Note that link provided above includes additional terms and conditions of the license.The opinions expressed in this publication are those of the authors and do not necessarily reflect the views of the Inter-American Development Bank, its Board of Directors, or the countries they represent.http://www.iadb.org 2016 Abstract * This paper discusses, from an analytical and operational perspective, the use of reserve requirements and loan loss provisions as countercyclical macroprudential instruments. In recent years both of these instruments have been used extensively in Latin America and elsewhere in the world. The first part of the paper sets the stage with a discussion of the rationale, in the presence of financial frictions, for using macroprudential regulation to mitigate financial system procyclicality. The second part reviews the general arguments, as well as the recent empirical evidence for Latin America, associated with the use of reserve requirements and loan loss provisions. The third part provides a normative analysis of the ways through which countercyclical reserve requirements and cyclically adjusted (or, more commonly called, dynamic) provisioning rules should be formulated, independently and jointly, to address concerns arising from procyclicality and financial volatility. Optimal countercyclical rules are discussed from the perspective of how these rules can either minimize a composite measure of economic volatility (combining measures of both macroeconomic and financial volatility) or maximize social welfare. The last part brings together the lessons for policymakers that can be drawn from the analysis. JEL classifications: E51, E58, G28

Growth and Welfare Effects of Macroprudential Regulation

“…To maximize growth and welfare, it is thus optimal to reduce μ as ε increases. The idea that it is desirable to impose high required reserve ratios on banks when their ability to monitor borrowers is weak is broadly consistent with the evidence [see Agénor and Pereira da Silva (2016) and Cerutti et al (2017)] which suggests that the use of reserve requirements remains widespread in developing countries and tend to be set on average at higher levels than in developed countries.…”

Forward Looking Loan Provisions: Credit Supply and Risk-Taking

“…Finally, some papers study the effect of the dynamic component of the provisioning schemes introduced as part of the macro-prudential toolkit of some countries (Agénor, and da Silva, 2016;Jiménez et al, 2017;Gómez et al, 2020). Notably, Jiménez et al, (2017) show that dynamic provisioning smooths credit supply cycles and, in bad times, supports firm performance.…”

“…Another stream of prior research on the relation between bank provisioning and economic cyclicality studies the dynamic component of the provisioning schemes introduced as part of the macro-prudential toolkit of some countries (Agénor, and da Silva, 2016;Jiménez et al, 2017;Gómez et al, 2020). The provisioning scheme we study is fundamentally different from the dynamic provisions in prior studies.…”

Evaluating the impact of macroprudential policies on credit growth in Colombia

“…The use of aggregate data has been used, in particular, to examine the use of reserve requirements, as these have been used by several countries in Latin America, including Colombia. The evidence suggests that these requirements had some transitory eects on credit growth and played a complementary role to monetary policy (Tovar et al (2012) Agénor & da Silva (2016) ). In the region, changes in reserve requirements were occasionally quite large, so the impact could have been signicant (Montoro & Moreno (2011)).…”