Alternative Evidence and Views on Asymmetric Loan Loss Provisioning

Abstract

Based on a linear provision/charge-off association and V-shaped scatter-plots of these variables against nonperforming loan changes, Basu et al. (2020) argue that nonperforming loan changes mis-measure credit quality and linear provision models are mis-specified. They conclude that residual asymmetry controlling for charge-offs results from loan heterogeneity and the real estate crisis. Using additions to non-accruals to measure credit quality, we find a linear association with provisions, that controlling for charge-offs induces mis-specification, and no evidence of provision asymmetry. These results highlight the importance of basing hypotheses and causal models on theoretical underpinnings rather than on plots subject to known fallacies.

Keywords: Loan Loss Provisions, Methodology

JEL Classification: M41, G20