Is Adequate The Method Of Loan Loss Provisioning? - Evidence From Romania

The importance of banking system within the financial system requires a special attention in order to secure its stability. Thus, with the occurrence of the financial crisis, in the context of integration of the financial system and creation of unique financial market, became more stringent the need for the existence of specific tools to prevent financial crises and to guarantee the continuity of normal economic activity. In this category are the macro-prudential supervision tools whose role is to reduce the ability of banks to damage the economy by taking on excess risk. Among them is registered the dynamic provisions intended to be used for enhancing bank soundness and to help mitigate part of the pro-cyclicality of the banking system. The current study addresses the methodology for establishing specific provisions for credit risk at the level of the Romanian banking system, highlighting the direct implications over the credit institutions, and indirect implications over the economy as a whole. The study presents as well the possible course of actions in order to remedy the weaknesses in the recognition of loan losses. Thus, while listing the specialty literature, study presents the regulatory framework applicable to loan loss provisioning, underlining the weaknesses of the static provisioning model and the need to look forward to the dynamic model along with the accounting methodology. In this regard it was considered the worsening of a loan portfolio in macroeconomic context and a hypothetical comparative study between the static and dynamic model has been realized. The results of the study revealed that the current provisioning model has a procycle character without considering the influence of macroeconomic factors over the future worsening of the loan portfolio without allowing recognition of future loan losses due to failure to identify future risks generating events and their credible assessment. Therefore it is required the need to establish reserves during the economic growth periods to cover losses from loans in order to prevent disruption of the banking activity and to limit the risk of insolvency. To achieve this goal it is necessary that all the parties involved, namely the banks, the regulatory authority and accounting organizations, to realize the importance of loan loss provisioning and act accordingly.