Bank loan loss provisioning for sustainable development: the case for a sustainable or green loan loss provisioning system

Abstract

The purpose of this study is to present a sustainable (or green) loan loss provisioning system that align bank loan loss provisioning with the sustainable development goals. The findings of the study are that the proposed sustainable (or green) loan loss provisioning system will align bank loan loss provisioning with the sustainable development goals by adjusting loan loss provisions estimates to reflect the environmental benefits and costs of borrowers' business activities. Banks will incur additional provisions above normal provisions for loans issued to businesses whose activities are harmful to the environment and the climate. Banks will allocate fewer provisions whenever they issue loans to eco-friendly or green businesses. The implication of the proposed sustainable (or green) loan loss provisioning system is that bank regulators and supervisors need to consider the impact of the sustainable (or green) loan loss provisioning system on bank capital and bank stability.

Sustainable development and bank non-performing loans: are they correlated?

“…They find that financial development stimulates both consumption and territory-based emissions in the short and long run. Ozili (2023b) considers the possibility of a sustainable (or green) loan loss provisioning system that align bank loan loss provisioning with the SDGs. Ozili (2023b) argued that a sustainable (or green) loan loss provisioning system will align bank loan loss provisioning with the SDGs by adjusting loan loss provisions estimates to reflect the environmental benefits and costs of borrowers' business activities.…”

“…Ozili (2023b) considers the possibility of a sustainable (or green) loan loss provisioning system that align bank loan loss provisioning with the SDGs. Ozili (2023b) argued that a sustainable (or green) loan loss provisioning system will align bank loan loss provisioning with the SDGs by adjusting loan loss provisions estimates to reflect the environmental benefits and costs of borrowers' business activities. While the above studies examined how sustainable development efforts by banks affect bank risk, none of these studies have examined how achieving the SDGs is correlated with bank NPLs.…”

“…Recently, banks are being pressured to show their commitment to the United Nations SDGs by providing tailored financial products, financial services and financial instruments that can help to accelerate the realization of the United Nation's SDGs by 2030 (Ozili, 2021). Pressuring banks to make a commitment to support one or more SDGs can push banks to extend credit to high-risk SDG-related activities that give rise to credit risk which manifest in the form of high NPLs in the banking sector when borrowers default on loan repayments (Ozili, 2023b). Pressuring banks to make a commitment to support one or more SDGs can also compel banks to diversify into lowreturn high-risk SDG activities so that they can appear to be supportive of the sustainable development agenda (Naqvi, Mirza, Rizvi, Porada-Rocho n, & Itani, 2021).…”

“…Few studies have examined how banks' involvement in financing sustainable development activities or projects can affect bank risk (see, for example, Umar, Ji, Mirza, & Naqvi, 2021;Ozili, 2023b). But none of these studies have examined whether bank lending to support the realization of the SDGs affect the size of bank NPLs.…”

Impact of Central Bank Digital Currency (CBDC) Activity on Bank Loan Loss Provisions

“…Credit risk is the single most important determinant of the size of loan loss provision (LLP) in banks (Bhat, Ryan, and Vyas, 2019). Other than credit risk, many factors also have an indirect effect on LLP such as economic policy uncertainty (Danisman, Demir and Ozili, 2021), competition (Dou, Ryan, and Zou, 2018), regulation (Nicoletti, 2018) and SDG activities (Ozili, 2023a), among others. However, one factor that has been ignored in the literature, but could have a significant effect on LLP -although indirectly -is central bank digital currency (CBDC) activity.…”