Regulatory Response of Myanmar: 1% general loan loss

provisioning
Prepared by Nyein Ei Cho

Brief Summary:

COVID-19 has harmed global economic activity since March 2020, causing microfinances’ borrowers to
lose their income, fall under poverty line, and be unable to repay their loans, posing several risks; these
include an increased risk of non-performing loans, abundant bank liquidity due to slowing loan demand,
and a decline in profitability. 1 Due to asset quality problems, banks’ provisioning requirements are
expected to increase significantly. Additionally, the capital adequacy ratio of banks would be affected
through higher risk-weighted assets while the increase in provisioning and reduction in interest income
would reduce net income thereby reducing further regulatory capital. As a response, regulators have
allowed or even mandated certain practices for microfinances, which include loan forbearance option,
which allows borrowers to buy time and restart repayments as the crisis's severe impacts fade, MFIs have
also voluntarily offered this option, since it seems to help them maintain the status of recorded assets and
liabilities2; relaxation on loan loss provisioning regulations and reduction on capital adequacy ratio to
prevent the MFIs from the risk of legally insolvency.

A short note on restructuring portfolios (debt relief):

Restructuring loan is named after the rescheduling and refinancing of the original loan. “All forbearance
measures are loan restructuring, but not all loan restructurings are forbearance measures.” 3

CGAP Pulse Survey reported that, as of April 2020, 88 percent of participant-microfinances had adopted
moratoria and other rescheduling forms, deviating from the original practices. 4

At the same time, the effects of

restructuring should be properly
reflected in the compilation of FSI5s to
track adverse trends related to
forbearance.

Loan Loss Provisioning Briefly

Explained: Focus on
Accounting Treatment

Provision constitutes an operating

expense in a bank's income statement.
Capital extended in the form of a loan is
1
https://www.imf.org/-/media/Files/Publications/covid19-special-notes/en-special-series-on-covid-19-treatment-of-restructured-loans-for-fsi-compilation.ashx

2
ibid
3
ibid

4
https://www.cgap.org/blog/moratoria-during-covid-19-how-are-they-working-out

1
the FIs' main productive asset and, hence, provisions for problem loans should be seen as the wear and
tear of the loan portfolio. Specific provisions flow into the asset side of the balance sheet with minus sign
to arrive at the figure for net loans by subtracting the value of the loan loss allowance from the nominal
value of the loan, reflecting the asset quality; the general provision is noted on the liabilities side in a
reserves account.
Specific provisions, which are ascribed to an identified deterioration of particular assets are
excluded from capital, while general provisions are regarded as created against unidentified losses and
freely available to meet losses which subsequently materialize. General provisions therefore qualify for
inclusion in the bank’s capital. “If the rescheduled loan subsequently becomes
delinquent, its classification must revert immediately
A regulatory authority might require that the bank must determine the allowance for loan losses
to the risk category it had prior to the rescheduling
for each category of classified loans such that the allowance ifreflects the difference between the nominal
this prior classification is a riskier one. The
value of the loan and a fair estimate of its current value, suchinstitution then must zero
as maintaining percent on
also establish the the nominal
appropriate
value of loans that are in the category "pass," but requiring allowances for loan losses equivalent
loan loss provisions and suspend accrual of to 20
percent for loans classified as "sub-standard," 5O percent for loans classified as
interest.”"doubtful, and 100
percent for loans classified as loss (but not written off). It is assumed that possible errors in measurement
should be in the direction of understatement rather than overstatement of net income and net assets, since
the expenses can lower the bank’s profits and its ability to pay out dividends. Both the regulatory and the
fiscal authorities have a legitimate interest in verifying the accuracy of provisioning rules and practices.
Most of the more complex prudential standards,
particularly capital adequacy rules, are based on sound
provisioning practices. When sound provisioning
practices are not in place, capital adequacy figures may
be severely distorted.6
Once loans have been renegotiated, the MFI should
revisit its loan portfolio to determine what, if any,
provisioning is required. Regarding restructured loans,
they should not be treated as current, either for
accounting purposes or for purposes of establishing loan loss provisions. As a rule, rescheduled loans can
be improved one step (to a less risky loan classification) when the borrower is current in servicing the
debt and has paid at least two installments of the rescheduled loan. If the rescheduled loan subsequently
becomes delinquent, its classification must revert immediately to the risk category it had prior to the
rescheduling if this prior classification is a riskier one. The institution then must also establish the
appropriate loan loss provisions and suspend accrual of interest. 7

The COVID-19 outbreak represents a severe negative economic shock that might translate into a sharp
increase in banks’ nonperforming loans (NPLs). Due to asset quality problems, banks’ provisioning
requirements are expected to increase significantly.Additionally, the capital adequacy ratio of banks
would be affected through higher risk-weighted assets while the increase in provisioning and reduction in
interest income would reduce net income thereby reducing further regulatory capital. Government
measures that may affect MFI lenders include government loan moratoria, changes in calculations of
reserves, provisioning requirements, regulatory reporting, and changes in prudential thresholds,
regulations, and requirements. 8 Therefore, a few examples of relaxation on provision requirements across
countries were described below for reference.

5
Financial Soundness Indicators
6
https://publications.iadb.org/publications/english/document/Principles-and-practices-for-regulating-and-supervising-
microfinance.pdf
7
https://publications.iadb.org/publications/english/document/Principles-and-practices-for-regulating-and-
supervising-microfinance.pdf
8
https://www.cgap.org/research/publication/crisis-roadmap-microfinance-institutions-covid-19-and-beyond

2
MFIs need stricter provisioning practices than banks or finance companies because their loans are less
collateralized.9

Risk in Solvency

Insolvency can be defined as the inability to pay debts. In the context of COVID pandemic, this can
happen for some reason the FI may end up owing more than it owns or is owed. 

To kick off, the basic equation Assets – Liabilities = Shareholder Equity should be known. If the
shareholder equity is positive, and the bank is solvent (its assets are greater than its liabilities). When
there is increasing rate of NPLs and some write offs, the value of asset portfolio will be deteriorated, and
then, the amount of write offs will be compensated by shareholders’ equity; the FI’s assets are worth less
than its liabilities, unable to repay all debts, therefore, FI is insolvent.

Other risk

It is a wrong concept to reduce or stop the operations in fear of loan default in this crisis, since if any
reason leads to such scenario, the portfolio size will be shrunk which may leads to reduced revenue and
then to inability to cover operational expenses.

Insolvency risks in Myanmar

Scenario 1: The Financial Regulatory Department as the supervisory authority and regulator of MFIs in
Myanmar, issued a loan restructuring policy for debtors that were affected by the pandemic in March
2020 to reduce the pandemic’s impact on solvency risk. The non-performing loan (NPL) restructured
based on this regulation can still be categorized as a performing loan, and the bank does not have to set
aside any loan impairment expenses. The policy is a quick response to the impact of COVID-19, relaxing
the rules for restructuring non-performing loans, and was enforced for the first time. It was extended
several times, until 31 March 2023. The restructuring policy aims to curb increase in NPL and allow time
for banks to strengthen their reserves for impairment losses on loans and capital to avoid the solvency
risk.

If LPP is not increased, it will impact on equity, but if LPP is not reduced, it will impact on asset
deterioration. Either way leads to insolvency, but the first attempt can be solved by the promotion of loan
growth, managing restructured loans, increasing bank operational cost efficiency, lowering interest
expenses, and increasing loan interest. And regulatory side should consider decreasing of CAR and LPP
rate.
(Countries where CAR is reduced, LPP is reduced, and )

Possible solution:
These include the promotion of loan growth, managing restructured loans, increasing bank operational
cost efficiency, lowering interest expenses, and increasing loan interest.
From regulatory side, the CAR and LPP should be decreased.

9
technical-guide-3rd-edition-english.pdf

3
4
 Table 1. Comparison of Regulations between Myanmar and selected South East Asian Countries (Before
Crisis and After Crisis)
The following table provides information on loan restructuring activity in Myanmar and in selected ASEAN countries in response to
the COVID-19 shock. The contents in the table are collectively based on different sources which are marked down in the foot note in
each page. For further countries and information, it is recommended to look at IMF policy tracker, which is an informative source with
updated measures.

Myanmar (As of Dec 2021) Cambodia (As of Sep 2020) Philippines (As of Dec 2020) Indonesia (As of Dec 2020)

LPP and Classification:10 LPP and Classification: LPP and Classification: LPP and Classification:
Before Crisis:
General provision for the portfolio = 1% 11, 2% 12of Before COVID: Before COVID: Before COVID:
portfolio
General provision for the portfolio = General provision = 1% of General provision for portfolio =
Provision as not applicable (NA) portfolio NA
Classification Past Due % of loan 30-day loans = 10% 1-30 days = 2% Allowance for doubtful loans:
OS 60-day loans <1 yr. = 30% 31-60 days and/or loans 180 days = 50%
Sub-standard 1~30 days 10% 180 days loans and/or > 1yr.=30% restructured once = 20% Allowance for compromised
31~60 Provision amount can be changed 61-90 days = 50% loans: 365 days = 100% 14
Watch 50%
days based on collateral. 91+days and/or loans restructured
61~90 *90-day loans < 1 yr.= 100% twice = 100% 13
Doubtful 75%
days *360-day loans >1 yr.= 100%
Over 91
Loan Loss 100%
days
Rescheduled loans Nil 50%
2nd Rescheduled
Nil 100%
loans

Restructuring: Restructuring: Restructuring: Restructuring:

After COVID: After COVID: After COVID: After COVID:

10
http://mekongbiz.org/wp-content/uploads/2017/02/ADB-MBI-MF-Benchmarking-Survey-10-Oct16-final-proof-DG-AB.pdf
11
Microfinance Supervisory Committee Directive No. 5/2016 (2016).

5
 Myanmar (As of Dec 2021) Cambodia (As of Sep 2020) Philippines (As of Dec 2020) Indonesia (As of Dec 2020)

On April 6, 2020, MFIs are instructed to negotiate NBC 16 issued the directive to
with borrowers and not to collect interest and restructure loans in March 2020 in
principal payments in compulsory mode, where priority sectors (tourism, garments,
the lending and collection of loans by MFIs was construction, transportation and
temporarily paused until 30 April 2020. The time logistics; (later extended the
period was further extended till 15 May 2020 and forbearance by another 6 months to the
September 2020 and then to December 2020 15; on end-June 2021 in all sectors, due to the
April 29 the moratorium was extended through recent nation-wide flooding in addition
May 15 through order 1/6 (318/2020). to the COVID-19 shock). Loans that
were 90 days late or less were meant to
be automatically restructured. 17
Financial Services Authority has
The IRR18 was set to implement a issued a loan restructuring policy
30-day grace period for all loans in March 2020; which aims to
with principal and/or interest curb the increase in NPL and
falling due within 17 March 2020 allow time for FIs to strengthen
to 31 May 2020. Lending their reserves for impairment
institutions shall grant an losses on loans and capital to
additional 30-day grace period avoid the solvency risk.
without imposing interest on
interest, penalties, fees and other
charges until the new due date
falls on or after 1 June 2020; then
the mandatory grace period was
ended on 1 June 2020 due to
lifting of restrictions on economic
activities across the country.

Accrued interest for the grace

period is payable on a staggered
basis over the remaining life of
the loan.

The authority directed FIs to

12
FRD 2014/1 Section 2(c)
13
BSP circular no. 409/2003

14
OJK Regulation 13/POJK.05/2014

15
The Microfinance Business Supervisory Committee vide Directive 2/2020

16
National Bank of Cambodia
17
https://www.imf.org/en/Topics/imf-and-covid19/Policy-Responses-to-COVID-19#V
18
Implementing rules and regulations

6
Myanmar (As of Dec 2021) Cambodia (As of Sep 2020) Philippines (As of Dec 2020) Indonesia (As of Dec 2020)

implement a one-time 60-day

grace period to be granted for the
payment of all portfolio fall due,
or any part thereof, on or before
31 December 2020. All loans
may be settled on a staggered
basis without interest on interests,
penalties and other charges until
31 December 2020. However, this
provision shall not apply to
interbank loans and bank
borrowings. 19

19
https://www.dfdl.com/wp-content/uploads/2020/12/DFDL-COVID-19-Government-Initiatives-Support-in-Asia-Dec-2020.pdf

7
 Myanmar (As of Dec 2021) Cambodia (As of Sep 2020) Philippines (As of Dec 2020) Indonesia (As of Dec 2020)

Prudential Relaxation focused on LLP: Prudential Relaxation focused on LLP: Prudential Relaxation focused on Prudential Relaxation focused on
LLP: LLP:
On September 2, 2020, FRD issued directive of The NBC will permit restructuring up
instructing MFIs to put only 1% general provision to three times without any impact to Regulatory relief to FIs that agree NPL restructured can still be
for the outstanding portfolio; to temporarily the loan classification during the to further loan term extensions or categorized as a performing loan,
eliminate the previous provision on loan referred period and all financial restructuring pursuant to the 60- and the FI does not have to set
classification during effective period.20 The institutions must follow. However, day grace period: (i) staggered aside any loan impairment
directive eases the burden on MFIs, because most MFIs complained that policy is booking of allowances for credit expenses. The incentives have
without it, loans with a past due period of 1 to 30 not a solution for all 2 million MFI losses, (ii) exemption from loan- helped keep non-performing loan
days would be provisioned at 10%, and clients.22 Note: MFIs in Cambodia loss provisioning, (iii) exemption (NPL) ratios below the
restructured loans with a first time 50 percent, and require land titles as collaterals, to from the limits on real estate regulator’s threshold of 5%.26
a second time 100 percent, respectively, will be cover the risks. 23 loans, when applicable, (iv) It was extended several times,
provisioned, putting MFIs’ solvency in high risk. exemption from related-party until 31 March 2023;27 which
The effective period runs from April 1, 2020, to transaction restrictions, and (v) allows banks to avoid making
June 20, 2021, with an extension until December non-inclusion in the FIs’ provisions for souring loans for a
20, 2021.21 reporting on non-performing year longer than originally set,
Note: All MFIs in Myanmar are not allowed to loans. 24 among other measures to help the
take collateral. industry, which saw loan growth
Note: Loans are secured on of 0.12% in September.28
pledged collaterals. 25 Note: Not prioritizing the
existence of collateral as
additional security29

Capital adequacy (total equity/total assets): Capital adequacy (total equity/total
Total equity/total assets >=15% 30 assets):
> = 15% of risk weighted assets. 31
10% capital adequacy for rural MFIs must maintain a solvency
banks and thrift banks.32 ratio of at least 10%34.
8% capital-to-risk- weighted
assets for savings and credit
cooperatives.33

20
FRD directive (712/2020)
21
FRD directive (712/2020)
22
https://cambodianess.com/article/cambodias-poorest-struggle-with-debt-as-microfinance-sector-profits-in-pandemic

8
Myanmar (As of Dec 2021) Cambodia (As of Sep 2020) Philippines (As of Dec 2020) Indonesia (As of Dec 2020)

9
Referring the comparison of regulatory response from Myanmar and neighboring countries, the
below points can be highlighted:

 In Myanmar, the current rules for loan classification and provisioning requirements
appear to be overly strict. In particular, the rule classifying a loan overdue by a day as a
sub-standard and requiring a 10% provisioning is too burdensome for all MFIs.35
 Also, in other countries, the regulators exempted the moratorium, rescheduled, and
restructured loans from counting of loan loss provision, or assuming NPL restructured
loans to be performing loan, given that their already-set provision on classification were
not overstated. It can also be due to the fact that MFIs from these countries are backed up
by the presence of collaterals. So as accounting treatment, the restructured loans need not
be considered as NPLs, calculating provision as long as they are entitled to restructured
loans. However, in Myanmar, the MBSC directive no (1/2021) stated that reduced the
general provisioning to be 1% on overall portfolio under the predetermined period, which
saved MFI industry, for the effective period, however unlike the other countries which
are restoring the economic activities back in major cities and sectors across country,
Myanmar is facing with massive downturn of economy, thus, the regulatory department
should extend the period of relaxation to the time until the situations in the MFI industry
becomes stable. 36

Situation of MIFIDA in FSIs focus on solvency risk

35
36
Based on CEO’s explanation and from reports

10
The Financial Regulatory Department as the supervisory authority and regulator of MFIs in Myanmar,
issued a loan restructuring policy for debtors that were affected by the pandemic in March 2020 to reduce
the pandemic’s impact on solvency risk. The non-performing loan (NPL) restructured based on this
regulation can still be categorized as a performing loan, and the bank does not have to set aside any loan
impairment expenses. The policy is a quick response to the impact of COVID-19, relaxing the rules for
restructuring non-performing loans, and was enforced for the first time. It was extended several times,
until 31 March 2023. The restructuring policy aims to curb increase in NPL and allow time for banks to
strengthen their reserves for impairment losses on loans and capital to avoid the solvency risk.

As of 30 June 2021, the proportion of restructured loans to total loans was 17.32%. estimated that the
NPL potential of the loan restructuring would range from 10 to 30% when the OJK policy is revoked.
Subsequently, the capital adequacy ratio (CAR) would decline, increasing the bank solvency risk. In
reference to this banking situation, the challenge is to estimate the bank solvency conditions based on
each bank’s capital capacity and potential NPL risk, and loan provisioning relaxation.

When conducting the intermediary function, the banking business receives third-party funds (TPF) or
savings that could be converted into loans to obtain an interest income. When interest income covers the
interest expense, operating expense, loan impairment losses expenses and tax, the bank reports some net
income as additional capital. During the COVID-19 pandemic crisis, interest income decreased, while
loan impairment losses increased, meaning that banks faced an increased solvency risk.

The financial assets account diagram shows the cycle of investment transactions to earn interest income
and maintain liquidity. In this situation, the bank prioritizes its liquid assets for investment in performing
loans and generating high returns, although it is necessary to anticipate the risk of loan default. A
defaulted loan then could be restructured and controlled as a restructured loan, while a defaulted loan that
could not be restructured could then be administered as an NPL. Since eliminating NPL write-off reduces
capital, the bank forms a loan lost provision (LLP). The NPL ratio is the early warning of loan risk, which
must not exceed 5%. The bank maintains adequate levels of liquidity in the form of liquid assets and
securities. The total balance between the two financial assets can meet the transaction payment needs for
the next 1 month. Investment in securities generates interest income.

11
Real linkage between LLP and solvency
 Under the Basel Capital Accord I (Basel I), banks’ provisions include identified losses (specific
provisions) and unidentified losses that are expected to occur (general provisions). Specific
provisions are those associated with identified loan losses or deterioration, while general
provisions pertain to losses that have not arisen yet but expected to emerge based on an
evaluation of economic and financial factors and the borrower’s ability to pay. The BCBS (2006)
recommends that valuation of loan impairment not be based solely on prescriptive rules or
formulae but also be enhanced by judgment from bank management. Under Basel II, loan loss
provisioning requirements incorporate the notion of default, past due and other indicative
elements. Even though Basel II provides no specific definition of non-performing loan (NPL), the
judgment of which is at the discretion of each jurisdiction, the threshold of 90 days overdue is
implied. According to Basel II, a default is

 Under the Basel Capital Accord I (Basel I), banks’ provisions include identified losses
(specific provisions) and unidentified losses that are expected to occur (general
provisions). Specific provisions are those associated with identified loan losses or
deterioration, while general provisions pertain to losses that have not arisen yet but
expected to emerge based on an evaluation of economic and financial factors and the
borrower’s ability to pay.
 Under Basel II, loan loss provisioning requirements incorporate the notion of default, past
due and other indicative elements.19 Even though Basel II provides no specific definition
of non-performing loan (NPL), the judgment of which is at the discretion of each
jurisdiction, the threshold of 90 days overdue is implied.
 General provisions, as defined by Basel II, are for possible or latent losses that are not yet
identified. Such provisions are sometimes calculated as a percentage of total loans.
Alternatively, they can be calculated by applying progressively higher percentages for
lower quality assets, reflecting the increasing probability of losses. For credit exposures
that are in default, banks must use their best estimate of expected losses based on the
principle that banks would have to recognize additional unexpected losses during the
recovery period.

12
  The measurement of provisions is directly linked to the capital ratio calculation. Under
Basel I, general provisions can be included in Tier II capital subject to the limit of 1.25
percent of risk-weighted assets; general provisions are intended to cover possible or latent
losses that have not yet been identified. Under Basel II, in the case of the standardized
approach to credit risk, general provisions can still be included in Tier II capital subject to
the limit of 1.25 percent of risk-weighted assets. In the IRB approach, the option to
explicitly include general provisions in Tier II capital does not exist; instead, the excess
of eligible provisions (which includes specific and general provisions) over expected
losses can be carried over to Tier II capital subject to a maximum of 0.6 percent of risk-
weighted assets. Creating specific provisions reduces income and thus has an adverse
impact on capital. Specific provisions are not included in capital because they are
established for expected losses that are explicitly tied to the exposures they cover, and
banks’ capital adequacy ratio should be the mirror of banks’ ability to absorb unexpected
losses. Under-provisioning is generally the single greatest distortion in the calculation of
capital and capital adequacy. Particularly when under stress, banks are likely to have an
incentive to underestimate credit risk, misclassify impaired assets, and postpone
recognition of losses so as to avoid large provisions which would depress stated
performance and limit refinancing opportunities at a critical time.
 Under Basel II, stipulations regarding provisioning aim at ensuring a sufficient level of
capital to cover banks’ credit risk. In this framework, future loan losses are classified into
two groups: expected losses and unexpected losses. The general concept is that capital
should provide adequate loss-absorption capacity on a going concern basis and a strong
enough incentive for its holders to monitor risk taking at banks. Consistent with this
concept, unexpected loan losses due to credit risk need to be covered directly by capital.
Expected losses (formulated under the product of the probability of defaults times the
loss given defaults), are used as a yard stick for banks to measure how the combination of
specific provisions and general provisions compares against expected losses.
 Capitalizaton: Some countries have the practice of using capital to mitigate rising
impairment losses, instead of putting in place sufficient provisioning—the so called
“capitalization approach.” There are pros and cons following this approach. Because the
economic values of loans are not readily observable, estimated provisioning would not
reflect exact expected losses. In this regard, some supervisors demand that more risky
banks increase their equity instead of increasing provisioning. They argue that a higher
CAR level will not create confusion for investors and will avoid an adverse credit rating
caused by high provisioning. On the other hand, the “capitalization approach” overstates
the capital level and retained earnings, and conceals the issues associated with rising
credit deterioration. It is not transparent and provides uncertainty about the quality of
banks’ balance sheets as weak banks show higher capital ratios but without disclosing
underlying weakness in the loan portfolio. It may also delay supervisors’ prompt
corrective actions based on predetermined capital adequacy ratios as well as bank
management actions on effective asset workout or foreclosure of collateral.
 Higher reported provisioning will reduce banks’ retained earnings and capital. These
reductions may induce a bank to undertake some behavioral changes such as issuing new
equity capital, reducing dividends, reducing the growth rate of its risky assets, conducting
a workout of NPLs, and taking other conservative actions that it otherwise might not have
undertaken.

13
  On balance, requiring higher provisioning seems preferable than requiring higher capital
ratios without proper provisioning. The latter would overstate capital and may result in
higher dividends, taxes, and a higher risk of insolvency later
 IAS 39 does not permit recognition in the Income Statement of any impairment losses
that are not based on objective evidence. This means that, strictly speaking, the additional
provisions set aside to satisfy regulatory requirements are not taken into account in
arriving at current year net profits, though this does not prevent the excess of
“regulatory” over “accounting” credit losses being deducted from capital and equity and
reported transparently. On the Balance Sheet, cumulative impairment losses measured per
IAS 39 are reflected in the “allowance account,” which is a contra asset account (or a
liability account) to net against the gross loan amount.
 The proper treatment would be to create a non-distributable capital reserve, or regulatory
reserve, for any shortfall between accounting and regulatory provisions. Specifically, a
regulatory expected loss buffer, which is built based on regulatory requirements, is
earmarked and reported transparently in the Retained Earnings instead of current year net
income.55 Regulatory provisions are not reflected in the “allowance account” on the
Balance Sheet, but rather a reclassification within Retained Earnings. This treatment
ensures compliance with IAS 39, while satisfying regulatory requirements. Additionally,
financial statement transparency is upheld while presentations and disclosures provide
investors with critical information to assess bank performance based on both accounting
and prudential measures.





14
Loan Loss Provisioning and its linkage to..

1. Loan loss reserves appear in two places in a bank’s financial statements: the balance sheet (Figure
1) and the income statement (Figure 2).
2. Outstanding loans are recorded on the asset side of a bank’s balance sheet. The loan loss reserves
account is a “contra-asset” account, which reduces the loans by the amount the bank’s managers
expect to lose when some portion of the loans are not repaid. Periodically, the bank’s managers
decide how much to add to the loan loss reserves account, and charge this amount against the
bank’s current earnings.
3. This “provision for loan losses” is recorded as an expense item on the bank’s income statement.
4. A relatively large accrual for commercial banks, loan loss provisions have a significant effect on
earnings and regulatory capital.
5. Because loan loss provisions are at the discretion of bank managers, there is the potential for
banks to provision more or less than necessary as a way to smooth their income.
6. From an accounting perspective, this could introduce discretionary modifications to banks’
earnings and reduce the comparability of results across firms.
7. From a prudential perspective, income smoothing could reduce the negative impact of asset
volatility on bank capital.It also could reduce banks’ procyclicality, since loan loss provisioning
potentially creates a feedback mechanism between the financial and real sectors of the economy.
If banks do not have sufficient reserves to absorb losses when economic conditions worsen, they
must rapidly increase their provisioning, which could cause them to curtail lending and
potentially prolong the downturn.37
8. The microfinance providers that entered the pandemic with strong equity positions will need to continue to
provision adequately and even take necessary write-offs of those portions of their microcredit portfolios
that have severely deteriorated in quality as a result of the pandemic. However, even the continued
solvency of better-capitalized microfinance providers should be monitored as elevated levels of
restructured portfolios persist.
9. Furthermore, as regulatory-imposed repayment “holidays” are lifted, previously undetected portfolio
quality issues in those microfinance providers may surface. Also, it can be difficult to distinguish
microfinance providers that have inherently weak business models but strong capital support of
shareholders from those that have fundamentally sound business models but lack such capital support. 38
10. What is needed in many cases is additional equity. This is particularly the case for microfinance
providers that were insufficiently capitalized before the pandemic and whose microcredit portfolios are

37
https://www.richmondfed.org/~/media/richmondfedorg/publications/research/economic_brief/
2012/pdf/eb_12-03.pdf
38
See today 2. Solvency and Microfiannce CGAP brief

15
 deteriorating, and for microfinance providers that now face increased regulatory pressure to meet higher
capital adequacy ratios (CAR).
11. However, new sources of equity are in short supply and existing equity providers, some
of whom are also under financial stresses, may not be able to or want to provide the additional equity
necessary to keep these microfinance providers afloat and help them to grow post-pandemic. Unless this
issue is proactively addressed, it is likely that microfinance providers will not have the equity they need to
speed and support their recovery post-pandemic. This has been borne out in previous crises where equity
was made available too late to do much good (Rozas 2021).
12. In addition, it would be useful to have renewed and improved clarity about the forms of regulatory
capital that satisfy the CAR requirements imposed on regulated microfinance providers, particularly where
those requirements are being increased.
13. Financial regulators that make the rules of the game clear to all and require accurate reporting by
regulated microfinance providers of their portfolio quality can strengthen the microfinance sector in their
jurisdictions by helping to instill market confidence in the microfinance providers under their supervision.
14. It is all about confidence in the microfinances’ financial position by the market, to get the support
of equity from providers to help microfinance grow with consistent new loans providing. Therefore,
regulatory authority can help strengthen the microfinance through some relaxation on regulatory capital
required to satisfy the CAR requirements through clear and renewed guidelines. (ME) (just take this for
11~14)
15. Loan loss provisions might be counted as regulatory bank capital. In the US, as well as in other countries (I e.
G-10 countries), general loan loss reserves are included as part of Tier 2 regulatory capital. Basel I, the current capital
framework, considers that general loan loss reserves are tier 2 capital up to 1.25% of risk-weighted assets. Therefore,
bank managers might have incentives to use loan loss provisions to alter regulatory capital ratios.
16. the purpose and definition of bank regulatory capital has been open to discussion, and in particular the role
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played by loan loss provisions.
17. managers use loan loss provisions to “manage” earnings and/or capital
18. Those that view earnings management as a practice that disguises the true economic value of firms and sends
distorted signals to the investors and any stakeholder of the company, would express their concerns if accounting
reforms and the change in the regulatory capital framework spur more discretion in managerial decisions with respect
to loan loss provisions.
19. Regarding the specific provision, for impaired loans (i. e. 90 days overdue)
20. If a loan had been in arrears for one year, the provision was applied to the whole amount due, not only to the
installments overdue. Moreover, if the 25% of the due amount was overdue, the whole outstanding amount of the loan
had to be used in order to calculate the specific provision for that loan.
21. Essentially, during good times, Spanish banks have to set aside provisions for the expected losses that are
embedded in expanding credit portfolios. The provisions made during those years are used to build up the socalled
statistical fund that might be depleted in bad times when the excesses of the last upturn appear in the form of impaired
assets. The former is achieved by comparing every quarter the latent loss in the credit portfolio (i. e. a fixed parameter
times the exposure) with the amount of specific provisions (which fluctuates significantly along the business cycle).
That difference, if positive, is charged into the P&L whereas, if negative, is written as income in the P&L statement
(provided that the statistical reserve has been previously build up).
22.
23.
24.

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 Poor quality of asset
Provision for loan loss Income

LPP can be distinguished as two types

Statement

Move through
Deduction

Loan Revenue
Loss (Net Interest
Provisioning Income)
(LLP)
General provision for
doubtful loans is no longer
Reserve for Loan loss Balance Sheet included in CAR

Deduction
Value of Asset

(Gross Loans)

Total Retained
Earnings

Total Capital

Includes in
Capital required
for CAR

MFI’s Activities such as dividend payouts

Source: Author’s own construction

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