Examination of loan-loss allowance practices by Hungarian banks

The question of the loan-loss allowance practices of Hungarian banks has received little attention in Hungarian literature. Yet according to international experience, loan-loss allowances, due to their magnitude, not only play a dominant part in the financial position of banks, but can even amplify the cyclicality of the economy. Hungarian loan-loss allowances are pro-cyclical. They move closely together with economic fluctuation, which poses a potential source of risk to financial and macroeconomic stability due to the existence of capital requirements. Real evidence is found of income-smoothing through loan-loss allowances. Capital management is realized by using general provisioning, which means a more favourable approach to financial stability. Loan-loss allowances are closely linked to risk-taking by banks. Banks prudently raise their loan-loss allowances almost simultaneously with an increase in credit expansion. However, it is found that the provisioning is strongly seasonal and based on the provisioning banks' estimation of expected losses, so that it is hardly accurate. These practices do not seem to be prudent.