Effect of Loan Loss Provisions on Financial Stability and Profitability of Banks

Abstract

LLPs are important accounting tools employed by banks to absorb a possible loss of non-performing loans and to deal with credit risk. They have a major influence on financial stability and profitability since they directly impact the capital adequacy, earnings and resilience of banks to economic shocks. This research paper examines how loan loss provisions impact on the financial health and profitability of banks, specifically commercial banks in Pakistan. Based on the Risk-Adjusted Performance model and the Prudential Regulation theory, the hypothesis of the research is that LLPs directly and indirectly affect the financial performance of banks. Secondary financial data on banks in the last ten years would be used following the application of quantitative research design whereby panel regression and correlation analysis would be used to determine the relationships. The results will be useful in terms of understanding the trade-off between risk-taking and profit maximization, presenting a suggestion to the bank management, regulators and policymakers in order to have a sustainable financial performance of the banking industry.