How Binding Is Supervisory Guidance ? Evidence from the European Calendar Provisioning

This paper investigates whether banks respond differently to supervisory guidance than to specificregulatory action. Using a sample of subsidiaries of European banks operating in developing countries, the studyexploits the sequencing in the supervisory and regulatory implementation of a reform on provisioning for credit lossesfor identification, generally referred to as European calendar provisioning. While the reform achieved theintended goal of reducing European banks’ nonperforming loan ratios, its effects were greater during the initialimplementation of the supervisory guidance than after its enactment as a binding regulation. This finding isconsistent with the notion that the subsequent formalization of the supervisory initiative within a regulatory frameworkachieved limited results because it eliminated the flexibility the regulatory authority had concerning thestringency with which European calendar provisioning was enforced. Finally, the study offers evidence of a mechanismthrough which policies in advanced economies affect banking outcomes in developing countries to which their localfinancial authorities should be alert.