Macroprudential Policies in Peru: The effects of Dynamic Provisioning and Conditional Reserve Requirements

Paper produced as part of the BIS Consultative Council for the Americas (CCA) research project on "The impact of macroprudential policies: an empirical analysis using credit registry data" implemented by a Working Group of the CCA Consultative Group of Directors of Financial Stability (CGDFS).

Summary

Focus

This paper assesses the effectiveness of dynamic provisioning and conditional reserve requirements, in Peru, where banks can grant loans in both domestic currency and US dollars. These measures had two distinct policy objectives. Dynamic provisioning aims to reduce the procyclicality of credit by allowing banks to build up loan loss provisions when their profits are growing in order to draw from them during economic downturns. Requiring higher reserves aims to reduce the dollarisation of the economy depending on the level of outstanding foreign currency credit.

Contribution

For this analysis, we employ a novel credit dataset covering the period of 2004-2014. This dataset contains detailed information on outstanding loans at the bank-debtor level. The database also contains information on loans in domestic and foreign currency. A highly dollarised banking system like Peru's can be vulnerable when the national currency depreciates. Moreover, over the past decade, credit in Peru has grown significantly. The mounting credit risk has created severe challenges for financial regulators.

Findings

The paper finds that dynamic provisioning slowed the high growth of commercial bank lending. This suggests that it helped reduce credit procyclicality. Second, banks with higher capital ratios were better able to expand credit. These banks were able to mitigate the impact of dynamic provisioning on their credit supply. Third, putting additional reserve requirements on foreign currency mortgage lending reduced dollarisation. In particular, this policy created incentives for banks to substitute dollar-denominated loans and expand credit in domestic currency.

Abstract

Over the past decade, credit has grown significantly in Peru, a small and partially dollarised economy, and the mounting credit risk attached to foreign currency credit created severe challenges for financial regulators. This paper assesses the effectiveness of two macroprudential measures implemented by regulators: dynamic provisioning, to reduce the procyclicality of credit and conditional reserve requirements, to diminish the degree of dollarisation of the economy. Using credit register data that covers the period of 2004-2014, we find evidence that dynamic provisioning has decelerated the rapid growth of commercial bank lending. Moreover, mortgage dollarisation declined significantly after the implementation of the conditional reserve requirement scheme.

JEL classification: E51, E52, E58, G21, G28

Keywords: Reserve requirement, dynamic provisioning, credit supply, macroprudential policy, dollarisation