The Expected Rate of Credit Losses on Banks' Loan Portfolios

Posted: 20 Dec 2017

See all articles by Trevor S. Harris

Trevor S. Harris

Columbia University - Columbia Business School

Urooj Khan

Columbia Business School - Accounting, Business Law & Taxation

Doron Nissim

Columbia University - Columbia Business School

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Date Written: December 18, 2017

Abstract

Estimating expected credit losses on banks’ portfolios is difficult. The issue has become of increasing interest to academics and regulators with the FASB and IASB issuing new regulations for loan impairment. We develop a measure of the one-year-ahead expected rate of credit losses (ExpectedRCL) that combines various measures of credit risk disclosed by banks. It uses cross-sectional analyses to obtain coefficients for estimating each period’s measure of expected credit losses. ExpectedRCL substantially outperforms net charge-offs in predicting one-year-ahead realized credit losses and reflects nearly all the credit loss-related information in the charge-offs. ExpectedRCL also contains incremental information about one-year-ahead realized credit losses relative to the allowance and provision for loan losses and the fair value of loans. It is a better predictor of the provision for loan losses than analyst provision forecasts and is incrementally useful beyond other credit risk metrics in predicting bank failure up to one year ahead.

Keywords: Banks; Credit Loss; Loans; Loan Loss Provisions; Bank Failure; Analyst Forecast; Standard Setting

JEL Classification: G14; G21; M41

Suggested Citation

Harris, Trevor S. and Khan, Urooj and Nissim, Doron, The Expected Rate of Credit Losses on Banks' Loan Portfolios (December 18, 2017). The Accounting Review, Forthcoming; Columbia Business School Research Paper No. 18-6. Available at SSRN: https://ssrn.com/abstract=3090133

Trevor S. Harris

Columbia University - Columbia Business School ( email )

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Urooj Khan (Contact Author)

Columbia Business School - Accounting, Business Law & Taxation ( email )

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New York, NY 10027
United States

Doron Nissim

Columbia University - Columbia Business School ( email )

3022 Broadway
604 Uris Hall
New York, NY 10027
United States
212-854-4249 (Phone)

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