Abstract - Monetary Transmission and Dynamic Provisioning through the Lens of Loan Loss Reserve on Credit Extension

This paper examines the effect of loan loss reserve on credit extension during economic recovery with a large cross section of banks from 1989 to 2012. I find strong evidence that the level of allowance for loan and lease losses has significantly positive effect on loan growth, after controlling for loan demand, capital, lending capacity, and portfolio quality. The results are robust with respect to bank size and all three recoveries in the study period. The results suggest a new bank balance sheet channel of monetary transmission. The findings also lend support to dynamic provisioning to counter the cyclical tightening in underwriting standard. My estimates suggest that a modest increase in loan loss provision could lead to a meaningful increase in credit availability during recovery.

Simon Kwan
Federal Reserve Bank of San Francisco
11. Jun. 2013

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