New research released by the Centre for International Finance and Regulation has shown how provisioning affects the quality and size of the Australian banking system's regulatory capital base. Researchers James Cummings and Kassim Durrani from Macquarie University used data provided by APRA on 22 banks operating in Australia between March 2004 and December 2012.Cummings, who presented the paper on loan loss provisioning at the CIFR Symposium on Market and Regulatory Performance yesterday, noted that the reporting mechanism used in Australia is different to that used elsewhere.One major aim of the Basel III reforms is to ensure individual banks build capital buffers that can be used in stressed economic conditions and to protect those same banks at times of excess credit growth.The effectiveness of these reforms, however, relies on the timeliness and reliability of banks' provisioning practices as loan losses are deducted directly from equity capital. The logic applied, then, is that a bank's capital adequacy will be overstated to the extent that its provisioning levels are inadequate to absorb expected credit losses in its business. With this in mind, the researchers examined loan-loss provisioning practices of Australian banks.They noted that, in a departure from accounting standards, the Australian banking regulator maintains a forward-looking provisioning model for the prudential supervision of banks. This research also examined the responsiveness of the regulatory provisions to bank-specific measures of credit risk and their relationship to regulatory capital under the Basel rules.The key findings of the CIPR research were that:•    Regulatory provisions reflect meaningful information about the default risk associated with banks' loan portfolios.•    Banks allocate part of surplus capital above Basel minimum requirements to pre-fund future credit losses through provisions (which holds for banks using either external or internal ratings-based approaches to credit risk).•    Banks accumulate additional provisions when their earnings are higher.These findings suggest that bank provisioning behaviour has both pro-cyclical and counter-cyclical characteristics - that is, the effectiveness of provisions is sensitive to cyclical fluctuations in default risk, and therefore banks have been adjusting their provisions to cushion the impact of cyclical fluctuations in capital adequacy and earnings.The researchers suggested that their study provided evidence banks use the regulatory provisioning model for risk management by building a buffer against future credit losses, and it is that practice which supports the stability of the bank capital base. By providing a loss-absorbing buffer, the provisions will reduce the extent to which capital is depleted in the event of a future economic downturn. Consequently, a sufficient provisioning buffer is likely to help alleviate the extent to which capital requirements act to restrict lending activities as a result of credit losses realised in the future.