A cycle responsive provisioning that is designed to help a bank deal with the effect of procyclicality. Dynamic provisioning allows early detection and coverage of credit losses in a bank’s loan portfolios, so that it can build up a buffer (of provisions) in good times to encounter unfavorable circumstances on an ongoing basis. The countercyclical (anticyclical) dynamism potentially improves the resilience of both individual banks and the banking system as a whole.

Dynamic provisioning, also known as forward looking loss provisioning, is an adjustment to a bank’s provisions for defaults on loans that takes into account the effects of the economic cycle, so that provisions increase during booms (strong balance sheets) and decrease during a recession/ downturn (weak balance sheets).

This type of provisioning aims to cope with the credit losses of a downturn by early detecting credit losses, particularly such losses that exceed normal levels established for normal conditions.

Dynamic provisioning is a macroprudential tool to enhance bank soundness and to mitigate or encounter the effect of procyclicality on the banking system. It can ensure that banks aren’t badly affected by increased loss reserves while still being able to stimulate an ailing economy during a downturn. So the dynamic provisioning requires that provisions for credit risk are created and incurred during booms when loan portfolios are expanding, and such provisions appear on the balance sheets of banks, although no allocation to specific loans have taken place.