Accounting and Control

Switching from incurred to expected loan loss provisioning

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This paper provides early evidence on the effect of global regulation mandating a switch from loan loss provisioning (LLP) based on incurred credit losses (ICL) to LLP based on expected credit losses (ECL). Using a sample of systemically important banks from 74 countries, we find that ECL provisions are more predictive of future bank risk than ICL provisions. Corroborating that the switch to ECL provisioning results in more information to assess bank risk, we also observe that the announcement of a larger first-time impact of the accounting change elicits lower stock returns and higher changes in CDS spreads. Critically, these patterns are most pronounced when credit conditions deteriorate. Additional analyses show that the higher information content of the ECL model stems from the provisions for non-defaulted loans, which did not exist under ICL. Our study contributes to the debate on the effect of the ECL model on procyclicality, an especially pressing issue in the context of the current pandemic.
Bibliographic citation: LÓPEZ, G., ORMAZABAL, G., SAKASAI, Y. (2021). Switching from incurred to expected loan loss provisioning. Early evidence. Journal of Accounting Research. doi:10.1111/1475-679X.12354.
Date: 01/02/2021
Author(s): Germán López; Gaizka Ormazábal; Yuki Sakasai
Document type: Article in Journal (refereed)
Department: Accounting and Control
Sector:
Languages: English