The Procyclicality of Loan Loss Provisions in Islamic Banks: Do Managerial Discretions Matter?

19 Pages Posted: 1 Mar 2016

See all articles by Wahyoe Soedarmono

Wahyoe Soedarmono

Sampoerna University - Faculty of Business

Sigid Eko Pramono

Bank Indonesia

Amine Tarazi

University of Limoges - Faculty of Law and Economic Science

Date Written: February 28, 2016

Abstract

This paper is the first to examine whether the loan loss provisioning behavior of Islamic banks is procyclical. From a dynamic panel data methodology, the empirical results show that loan loss provisioning in Islamic banks is indeed procyclical, as higher economic growth leads to a decline in loan loss provisions. A closer investigation is also conducted to examine whether capital management, income smoothing, or signaling behavior can alter the procyclicality of loan loss provisions. Specifically, our results document that only capital management behavior can overcome the procyclicality of loan loss provisions. This paper therefore advocates the importance of strengthening discretionary behavior in Islamic banks in terms of capital management using loan loss provisions, particularly during economic boom.

Keywords: Islamic banks, loan loss provisions, procyclicality

JEL Classification: G15, G21, M41

Suggested Citation

Soedarmono, Wahyoe and Pramono, Sigid Eko and Tarazi, Amine, The Procyclicality of Loan Loss Provisions in Islamic Banks: Do Managerial Discretions Matter? (February 28, 2016). Available at SSRN: https://ssrn.com/abstract=2739485 or http://dx.doi.org/10.2139/ssrn.2739485

Wahyoe Soedarmono (Contact Author)

Sampoerna University - Faculty of Business ( email )

Jl. Raya Pasar Minggu, Kav. 16
Jakarta, Pancoran 12780
Indonesia

Sigid Eko Pramono

Bank Indonesia ( email )

JL. M.H. Thamrin No. 2
Jakarta, 10350
Indonesia

Amine Tarazi

University of Limoges - Faculty of Law and Economic Science ( email )

5 rue Felix Eboue
Limoges, 87000
France

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