CECL: Timely Loan Loss Provisioning and Bank Regulation
58 Pages Posted: 25 Feb 2020 Last revised: 7 Apr 2022
Date Written: September 6, 2020
We investigate how provisioning models affect bank regulation. We study an accuracy vs. timeliness trade-off between an incurred loss model (IL) and a current expected credit loss model (CECL). Relative to IL, CECL improves efficiency by enabling timely intervention to curb inefficient ex post asset-substitution even though the imprecise information of CECL entails false alarms. However, from a real effects perspective, our analysis uncovers a potential cost of CECL: banks respond to timely intervention by originating riskier loans so that timely intervention induces timelier risk-taking. By appropriately tailoring regulatory capital to information about credit losses, the regulator can improve the efficiency of CECL. In particular, we show that regulatory capital under CECL would be looser when early estimates of credit losses are sufficiently precise and/or risk-shifting incentives are not too severe. From a policy perspective, our analysis suggests that better coordination between standard setters and bank regulators could enable the latter to relax capital requirements in order to spur lending.
Keywords: CECL; Expected Loss Model; Incurred Loss Model; Capital Requirements; Loan Loss Provisioning; Real Effects; Banking Regulation
JEL Classification: G21, G28, M41, M48
Suggested Citation: Suggested Citation