Banks' procyclical behavior: Does provisioning matter?

A panel of 186 European banks is used for the period 1992-2004 to determine if banking behaviors, induced by the capital adequacy constraint and the provisioning system, amplify credit fluctuations. We find that poorly capitalized banks are constrained to expand credit. We also find that loan loss provisions (LLP) made in order to cover expected future loan losses (non-discretionary LLP) amplify credit fluctuations. By contrast, LLP used for management objectives (discretionary LLP) do not affect credit fluctuations. The findings of our research are consistent with the call for the implementation of a dynamic provisioning system in Europe.