The distribution of the non-performing loan ratio across countries is correlated with changes in real GDP. However, the coverage of non-performing loans by provisions does not exhibit similar regularities. Provisioning ratio is strongly influenced by national regulators. This is why a survey on the tightness of asset classification and provisioning regulations was conducted in seven countries of New Europe. The survey has shown that Croatia has the strictest regulations in two areas: (1) the calculation of loan loss provisions on the basis of the present value of cash flows has largely been replaced by the calculation based on the number of days in default (which has pushed criteria of collateral values to the background); (2) the calculation of loan loss provisions in case of loan restructuring depends on whether only a loan is restructured or overall debtor’s business operations are being restructured, while the possibility of loan reclassification to better categories does not fully reflect on the possible restoration of a debtor's financial soundness. The question remains open as to the correlation between tight regulation and banks' credit activity. This is particularly important regarding financial restructuring of debtors with a positive operating cash flow after restructuring.
It is reasonable to assume that classifications and provisioning for the purpose of preserving banking system soundness must be stricter in a system with poor institutions. On the other hand, excessive strictness may further hinder the restructuring process which is already difficult because of the poor institutional framework. Finding a right regulatory balance is a difficult task in such circumstances.
CBA Analysis 56 - NPL regulation