The cyclicality of loan loss provisions under three different accounting models: the United Kingdom, Spain, and Brazil

A. M. B. Araujo; P. R. B. Lustosa

arxiv: 1907.07491 · v1 · pith:J2XQ2PKInew · submitted 2019-07-17 · 💰 econ.GN · q-fin.EC

The cyclicality of loan loss provisions under three different accounting models: the United Kingdom, Spain, and Brazil

A. M. B. Araujo , P. R. B. Lustosa This is my paper

Pith reviewed 2026-05-24 19:59 UTC · model grok-4.3

classification 💰 econ.GN q-fin.EC

keywords loan loss provisionsbusiness cyclepro-cyclicalaccounting standardsincurred loss modelexpected loss modelGDP growth

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The pith

Loan loss provisions show pro-cyclical behavior in the UK, Spain, and Brazil under their respective accounting models.

A machine-rendered reading of the paper's core claim, the machinery that carries it, and where it could break.

The paper investigates the relationship between loan loss provisions and the business cycle under three accounting models. The United Kingdom uses an incurred loss model, Spain an expected loss model, and Brazil a mixed model. Data from commercial banks between 2001 and 2012 are analyzed with an econometric model that includes financial and macroeconomic variables. The results indicate pro-cyclical behavior in all three countries, where provisions decrease as GDP grows and increase as GDP contracts. This occurs despite the models' differing designs regarding cyclical effects, and earnings management also plays a role.

Core claim

Despite the accounting models of the three countries being formed by very different rules regarding possible effects on the business cycles, the results revealed a pro-cyclical behavior of provisions in each country, indicating that when GDP grows, provisions tend to fall and vice versa.

What carries the argument

Econometric regression of loan loss provisions on variables measuring credit risk, earnings management, capital management, GDP growth, and unemployment rate.

If this is right

Provisions are lower when GDP is growing in all three models.
Earnings management influences the level of provisions.
Capital management and credit risk behavior also affect provisions.
The mixed model in Brazil behaves similarly to the others in terms of cyclicality.

Where Pith is reading between the lines

These are editorial extensions of the paper, not claims the author makes directly.

Expected loss models may not deliver countercyclical provisioning without additional regulatory adjustments.
The choice of accounting model alone appears insufficient to change the cyclical pattern of provisions.
Similar patterns might appear in other countries adopting expected loss rules after the sample period.

Load-bearing premise

The econometric model with the selected financial and macroeconomic variables correctly measures the link between economic cycles and provisions without important missing factors.

What would settle it

A dataset showing that provisions rise or stay flat when GDP grows, or that the Spanish banks display countercyclical provisions.

read the original abstract

A controversy involving loan loss provisions in banks concerns their relationship with the business cycle. While international accounting standards for recognizing provisions (incurred loss model) would presumably be pro-cyclical, accentuating the effects of the current economic cycle, an alternative model, the expected loss model, has countercyclical characteristics, acting as a buffer against economic imbalances caused by expansionary or contractionary phases in the economy. In Brazil, a mixed accounting model exists, whose behavior is not known to be pro-cyclical or countercyclical. The aim of this research is to analyze the behavior of these accounting models in relation to the business cycle, using an econometric model consisting of financial and macroeconomic variables. The study allowed us to identify the impact of credit risk behavior, earnings management, capital management, Gross Domestic Product (GDP) behavior, and the behavior of the unemployment rate on provisions in countries that use different accounting models. Data from commercial banks in the United Kingdom (incurred loss), in Spain (expected loss), and in Brazil (mixed model) were used, covering the period from 2001 to 2012. Despite the accounting models of the three countries being formed by very different rules regarding possible effects on the business cycles, the results revealed a pro-cyclical behavior of provisions in each country, indicating that when GDP grows, provisions tend to fall and vice versa. The results also revealed other factors influencing the behavior of loan loss provisions, such as earning management.

Editorial analysis

A structured set of objections, weighed in public.

Desk editor's note, referee report, simulated authors' rebuttal, and a circularity audit. Tearing a paper down is the easy half of reading it; the pith above is the substance, this is the friction.

Desk Editor's Note private letter to a colleague

The paper finds pro-cyclical provisions under all three accounting models using bank data from 2001-2012, but the regressions lack enough detail to confirm the GDP link is isolated.

read the letter

The central result is that loan loss provisions fall when GDP rises in the UK under the incurred loss model, in Spain under the expected loss model, and in Brazil under the mixed model. The authors run regressions on commercial bank data covering 2001-2012 and report a negative GDP coefficient in each country after including earnings, capital, and unemployment variables. They also note earnings management effects. This three-country comparison is the main contribution and directly tests whether the shift to expected loss rules changes cyclicality in practice. The sample period includes both boom and crisis years, which gives the test some power. The finding that the expected loss regime in Spain still shows pro-cyclical provisions is the part worth paying attention to if the specification holds. The soft spot is the econometric setup. The abstract only says an econometric model with financial and macroeconomic variables was used, with no equation, no mention of bank fixed effects, lag structure, or checks for reverse causality from provisions to GDP. That leaves open the possibility that omitted factors or endogeneity drive the result rather than the cycle itself. If the full paper includes standard dynamic panel methods and robustness tables, the concern shrinks; without them the claim is harder to trust. This paper is for researchers and regulators focused on how accounting standards affect bank provisioning and financial stability. Readers working on the practical impact of expected loss models would get the most from the cross-country evidence. It deserves peer review because the question is policy-relevant and the data span is decent, though the methods section will need expansion before publication.

Referee Report

2 major / 1 minor

Summary. The paper analyzes the cyclicality of loan loss provisions across three accounting regimes using bank-level data from the UK (incurred-loss model), Spain (expected-loss model), and Brazil (mixed model) over 2001–2012. It estimates an econometric specification containing financial and macroeconomic variables and reports that provisions are pro-cyclical in all three countries (negative association with GDP growth), with additional effects from earnings management, credit risk, and capital management.

Significance. If the reported negative GDP coefficients survive checks for endogeneity and omitted variables, the result would indicate that the expected-loss model does not deliver the counter-cyclical buffer often claimed for it, with direct implications for the design and evaluation of IFRS 9.

major comments (2)

[Abstract / Econometric specification] Abstract and econometric-model description: the paper states only that “an econometric model consisting of financial and macroeconomic variables” was used, without reporting the precise equation, lag structure, bank or time fixed effects, or instrumentation strategy. Because the central claim is that the GDP coefficient isolates pro-cyclicality, this omission is load-bearing; the reader cannot assess whether reverse causality (provisions affecting credit supply and GDP) or omitted time-varying factors have been addressed.
[Results / Discussion] The pro-cyclical finding rests on the maintained assumption that the chosen controls (earnings, capital, unemployment) fully absorb confounding variation. No robustness checks, alternative specifications, or tests for endogeneity are referenced in the abstract; without them the reported negative GDP coefficient cannot be interpreted as the partial correlation required by the paper’s conclusion.

minor comments (1)

[Abstract] The abstract gives the sample period (2001–2012) but supplies no information on the number of banks, observations, or data sources per country; these details belong in the data section.

Simulated Author's Rebuttal

2 responses · 0 unresolved

We thank the referee for the constructive comments, which highlight opportunities to improve the clarity of our econometric approach and abstract. We address each major comment below.

read point-by-point responses

Referee: [Abstract / Econometric specification] Abstract and econometric-model description: the paper states only that “an econometric model consisting of financial and macroeconomic variables” was used, without reporting the precise equation, lag structure, bank or time fixed effects, or instrumentation strategy. Because the central claim is that the GDP coefficient isolates pro-cyclicality, this omission is load-bearing; the reader cannot assess whether reverse causality (provisions affecting credit supply and GDP) or omitted time-varying factors have been addressed.

Authors: We agree the abstract is concise and omits these details. The full manuscript (Section 3) specifies a dynamic panel regression with the loan loss provision ratio as the dependent variable, including bank fixed effects, time fixed effects, a lagged dependent variable, and controls for earnings, capital, credit risk, GDP growth, and unemployment. No additional instrumentation is employed. We will revise the abstract to include a brief description of the model (bank and time fixed effects plus key controls) and add a short discussion of reverse causality, noting that provisions represent a small share of aggregate GDP and fixed effects mitigate time-varying confounders. revision: yes
Referee: [Results / Discussion] The pro-cyclical finding rests on the maintained assumption that the chosen controls (earnings, capital, unemployment) fully absorb confounding variation. No robustness checks, alternative specifications, or tests for endogeneity are referenced in the abstract; without them the reported negative GDP coefficient cannot be interpreted as the partial correlation required by the paper’s conclusion.

Authors: The full paper presents the main specification with these standard controls and interprets the negative GDP coefficient as evidence of pro-cyclicality conditional on them. Robustness checks (alternative lags, subsample periods, and additional controls) appear in the appendix and results section. We will revise the abstract to reference that 'findings are robust to alternative specifications' and expand the discussion to explicitly address endogeneity concerns and the limits of the controls. revision: yes

Circularity Check

0 steps flagged

No circularity: empirical regression on independent bank data

full rationale

The paper is a standard cross-country panel regression study. It estimates the partial correlation between loan loss provisions and GDP (plus controls) using 2001-2012 bank-level data from the UK, Spain, and Brazil. No derivation, first-principles prediction, fitted parameter renamed as out-of-sample forecast, or self-citation chain is present. The central claim (pro-cyclical provisions) is an empirical coefficient, not a definitional identity or self-referential result. The analysis is therefore self-contained against external data benchmarks.

Axiom & Free-Parameter Ledger

1 free parameters · 1 axioms · 0 invented entities

Empirical econometric study that fits regression parameters to observed bank-level and macro data rather than deriving results from first principles.

free parameters (1)

regression coefficients on GDP, unemployment, earnings, and capital variables
Coefficients are estimated from the 2001-2012 bank data in each country.

axioms (1)

domain assumption The selected financial and macroeconomic variables adequately capture the determinants of loan loss provisions
Invoked when attributing observed patterns to cyclicality and earnings management.

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discussion (0)

Lean theorems connected to this paper

Citations machine-checked in the Pith Canon. Every link opens the source theorem in the public Lean library.

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unclear
Relation between the paper passage and the cited Recognition theorem.

A panel data econometric model was specified in which the loan loss provision expense in relation to total assets is regressed against the variation in Gross Domestic Product (GDP)

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