Unexpected Banking Loan Losses in an Estimated DSGE Model

In spite of realizing more loss than expected and reserved provision in loaning process, some of our banks avoid recognizing the losses, through extension of the loan contracts and consequently do not shift the realized losses to their capital. With this in mind, the major objective of this study is to design a frame-work, through which we can explain the differences between the results of the current and the legal approaches in banking operation, within the following models: 1- Model CU, which indicates the current practice of banking system in avoiding loss recognition through extension of the loan's contracts. 2- Model BM, which is a benchmark model and in line with the legal rules 3- Model AT, which represents the replacement of predetermined loan rate with a realized one (with close similarity to participation loans), as an alternative method. The analysis of the impulse responses of models, within the DSGE frame-work, shows that considering the legal requirements of the banks, will amplify the effect of the shocks to the real economy and if the loan rates are determined based on the realized return, instead of predetermined rate, the bank's unexpected loan losses will decline, in the face of many negative shocks.