|As two of the joint authors of the IMF Working Paper WP/00/195 referred to in Mr. Manasoo's note, we have identified three important issues for comment:
(i) whether the general provisions made on pools of exposures with similar characteristics should be accounted for as a capital item in the balance sheet or as an expense;
(ii) the asset classification system as outlined in the same IMF working paper seems to be simplified in consideration of the new capital accord (Basel II);
and (iii) the incentives for provisioning are highly dependent on the country's taxation system.
In that regard, please find our views:
· When banks establish general provisions, they usually charge them as expenses like any specific provision.
· Since general provisions do mirror potential (as yet unspecified) losses and consequently are determined on good and performing loans, they can be included in Tier II capital as stipulated in Basel Capital Accord ( Basel I ) up to certain limits. Thus, if a provision on pools meets that definition, it can be included in Tier 2 for prudential purpose.
· The footnote 9 of the alluded paper only tries to explain that provisioning means "expenses" and "allowance account" means a balance sheet item as per accounting terminology. Hence, it does not argue that general provisions should not be charged as expenses. If you were interested on numerical illustrations of provisioning examples, we may suggest referring to Table 6 (page 21) of the alluded working paper (IMF WP/00/195).
· Finally, so far the proposed Basel II does not intend to change the definition of Tier I and II capital. It is our understanding that the Basel Committee could consider such as a proposal as a part of a comprehensive review of all aspects of the definition of capital.
Simplistic Assets Classification System
Regarding asset classification systems, in a number of countries two different types of asset classification coexist, one is the "internal risk management" classification of each bank based on its own probability of default and other considerations, and the other is the "regulatory" asset classification system, usually established by the supervisory authorities. In sophisticated banking systems, the internal classification does not necessarily match the regulatory classification because the latter would be deemed as somewhat basic. The asset classification system which the IMF working paper outlined is a regulatory classification system. As a matter of fact, a number of countries cannot satisfy even this basic regulatory asset classification system.
As indicated in Mr. Manasoo's comment, once it is effective, the Basel II could contribute to developing more sophisticated "internal" and "regulatory" asset classification system.
Tax Incentive for Provisioning
Regarding tax-deductibility on provisioning, as indicated in the IMF working paper on pages 18-21, providing tax deductibility for provisioning give a strong incentive for banks to adequately establish provisions and to do so in a timely fashion. Having said that, regardless tax incentives, bankers are responsible for keeping adequate levels of loan loss provisioning and the banking supervisors for ensuring the timely recognition of loan losses by bankers.
Inwon Song and Luis Cortavarria -Checkley