Provisioning in Slovenian banksProvisioning in Slovenian banks

Presentation for 17th BSCEE Conference

Ms. Nataša Pukl, Director of the Banking Supervision DepartmentDubrovnik, 27 May 2004

PRESENTATION OUTLINEPRESENTATION OUTLINE

• Introduction

• History

• Current provisioning and the tax regime– specific provisions– provisions for general banking risks

• Future– Application of IFRS– Statistical or dynamic provisions

INTRODUCTIONINTRODUCTION

• Loan rewiev and provisioning as a core elements of : – any bank’s risk management system and

– of prudential oversight

• Supervisors in many countries rely on standard systems of loan classification and set standard provisioning levels

•

HISTORY OF PROVISIONING IN HISTORY OF PROVISIONING IN SLOVENIASLOVENIA

• Starting with general provisions in 1991

• Since the beginning of 1994 to 1999– general provisions – and specific provisions

both based on classification of assets

• From 1999 -– provisions for general banking risks – specific provisions for credit and country risks– specific provisions for other risks

•

SPECIFIC PROVISIONSSPECIFIC PROVISIONS

Specific provisions for credit risks :

– based on loan classification (also off-balance items)

– minimum level • 1% on group A (except state and central bank)• 10, 25, 50 and 100 % on group B-E

– tax deductibility allowed

– not considered as a capital component

SPECIFIC PROVISIONSSPECIFIC PROVISIONS

Specific provisions for country risks:

– minimum level (%) on risky countries

– tax deductibility allowed

– not considered as a capital component

Specific provisions for other risks– for other known risks (bank’s assessment)

– not tax deductable, not part of capital

PROVISIONS FOR GENERAL BANKING PROVISIONS FOR GENERAL BANKING RISKSRISKS

• the level not prescribed

• included in capital (Tier 1) as funds for general banking risks (EU Directive 2000/12 - Article 34 (2)

• not tax deductable

LEVEL OF PROVISIONSLEVEL OF PROVISIONS

• High level of established provisions in banking system

in %

Ratios 2000 2001 2002 2003

Adjustments / Bad and doubtful Assets (B-E)

45,3 44,6 38,0 35,1

Specific provisions /

Total classified on- and off-balance sheet items

6,2 6,3 8,4 7,7

Specific provisions /

Capital (calculated)

90,8 103,5 97,2 89,9

FUTURE – Application of IFRSFUTURE – Application of IFRS

• EU (1606/2002 EC) regulation on the mandatory application of IFRS for consolidatedaccounts of listed companies

• EU Endorsement of IFRS standards with the exception of IAS 32/39

• Expectation that from 1 January 2005 the Slovenian banks will use IFRS

FUTURE – Application of IFRSFUTURE – Application of IFRS

• Application of IFRS (IAS 39) means fair value principle in evaluation of financial instruments

• A financial assets is impaired and impairment losses are incurred if there is objective evidence of impairment as a result of a past event that occured subsequent to the initial recognition of assets. Expected losses as a result of future events are not recognised.

• According to IFRS the Slovenian banks will have a specific provisions surplus (it should be retained as a reserve or capital item that could not be used for distribution to shareholders)

STATISTICAL OR DYNAMIC PROVISIONSSTATISTICAL OR DYNAMIC PROVISIONS

• Thinking about the statistical provisions in Slovenia• The StP were first introduced in Spain (in July 2000)• Objectives of statistical provisioning:

1. to acknowledge the expected or latent loss as a cost2. to counterbalance the cyclical behaviour of the existing loan

loss provisions (LLP)3. To correct the excess volatility of bank profits: - Low (high) LLP in the upturn (downturn) may overstate

(understate) profits - Bank profitability and solvency could be distorted:

overvaluation of dividends, erosion of capital

STATISTICAL OR DYNAMIC PROVISIONS STATISTICAL OR DYNAMIC PROVISIONS

• Statistical provisions: StP=Lr-SPLr = Latent risk (estimated expected loss), SP = Specific provisions

• If Lr > SP => StP > 0

- StP charged in the Profit&Loss Account

- Building up the Statistical Fund

• If SP > Lr => StP < 0

- StP written as income in the Profit&Loss Account

- Depletion of the Statistical Fund

• The Statistical Fund may not exceed three times the value of the latent risk (estimated expected loss)

STATISTICAL OR DYNAMIC PROVISIONSSTATISTICAL OR DYNAMIC PROVISIONS• Calculation of expected loss by:

- internal models that must be approved by central bank- standard approach: six risk categories with the corresponding coefficients: - without risk (0%) – public sector - low risk (0,1%) - medium risk (0,6%) - medium-high risk (1%) - high risk (1,5%) - credit card balances, current account overdrafts and credit account excesses

• Latent risk = coefficients multiplied by the exposure• The Statistical provision is set aside on quarterly basis by

one fourth of the annual amount

DILEMMAS !!!DILEMMAS !!!

• Is the system of dynamic provision in accordance with IAS 39 rules (fair value principle) ?

• Would the system of dynamic provision have the desired effect ?The Slovenian banks have a significantly higher level of provisions than Spanish banks when dynamic provisions were introduced.

• When the system of dynamic provision should be introduced to Slovenian banks?

• Adequate tax treatment of dynamic provisions and their inclusion in the calculation of capital (tier II)