The Cyclicality of Allowance for Impairment Losses in Indonesia

As post October 2012, the arrangement of loan loss provisioning in Indonesia had changed into Allowance for Impairment Losses (CKPN). As a new form of loan loss provisioning, CKPN aims to prevent banks from losses by forming a provision for the asset impairment based on bank self-assessment. There have been many works done concerning cyclicality of loan loss provisioning in some countries with the result that the establishment of provision by banks tends to be procyclical. As a result of this behaviour, if there is a weakening of the economy, banks will tend to form additional provisions that can reduce their profitability and CAR. This study examines how loan loss provisioning of Indonesian banks especially since the implementation of allowance for impairment losses (CKPN) responds to their earning, credit growth, and to the changes in the business cycle (reflected by GDP growth) using panel data of 102 banks in Indonesia during the period of 2011q1–2017q1. We find empirical evidence that banks on average have followed an income-smoothing pattern as evidenced by the positive and significant relationship between loan loss provisions and bank earnings. On the contrary, credit growth and GDP growth has an undesirable negative coefficient which means tend to be procyclical. As a conclusion, the results suggest that, on average, Indonesian behaviour of banks loan loss provisioning follow a procyclical pattern that is potentially worsening the business cycles, especially during a recession period.