This means that a credit expansion process is likely to lead to some credit quality problems in roughly that time horizon. The average duration of the economic cycle (from boom to bust) is similar. This implies that if banks only look at contemporary bad loans to determine their credit risk policies, they will restrain credit and increase risk premia in the downturn. The higher cost of funding for bank-dependent borrowers will feed back to activity, reinforcing recessionary forces. I turn now to provisions. In Spain, until year 2000, loan loss provisions were strongly pro-cyclical (as in many other countries), because they were largely linked to the volume of contemporaneous problem assets. This static provisions are backward-looking, they are based on past events. Only are accounted for loan by loan when borrowers fail to repay or in some cases when the situation of the borrower deteriorates significantly. As a consequence, the ratio of provisions to total loans fell therefore during periods of economic growth and tended to rise considerably during downturns (see lower part of Graph 3). As a result of this, the latent risk of loan portfolios was not properly recognised in the profit and loss account under the old system. In periods of economic expansion the fall in doubtful loans went hand in hand with the decrease in provisions, which in turn allowed bank managers to improve bottom-line profits.
In the published accounts it will be deducted from the book value of the credit items that produce it. It is not considered a reserve to be integrated in the regulatory own funds. The annual accounts shall report the various solvency provisions (or value adjustments), and their method of computation. The statistical provision is not a tax-deductible expense although banks can use an asset account of anticipated taxes (i.e. the impact on the profit and loss is neutral but still negative in terms of cash flows). Finally, given the considerable internationalisation of our banking system in recent years, it is important to keep in mind that the statistical provision is required on an individual level of all the members of a consolidated banking group. It is not possible to counter a positive statistical provision requirement in one bank with a negative one in another bank of the same group. This individual bank approach reinforces the statistical provision requirement and squares well with the fact that expected losses arise at an individual bank portfolio level. By now, you are probably wondering about the real impact of the statistical provision in the Spanish banking system. As far as the profit and loss account is concerned, the statistical provision for depository institutions represents around 12% of 2001 total operating margin. At the end of 2000 the statistical fund reached 15% of its maximum amount (remember there is a cap of three times the latent risk) and at the end of 2001 it stands at 27%.