CECL: Timely Loan Loss Provisioning and Bank Regulation

61 Pages Posted: 25 Feb 2020 Last revised: 8 Sep 2020

See all articles by Lucas Mahieux

Lucas Mahieux

Tilburg University - Tilburg University School of Economics and Management

Haresh Sapra

Booth School of Business, University of Chicago

Gaoqing Zhang

University of Minnesota

Date Written: September 6, 2020

Abstract

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

Mahieux, Lucas and Sapra, Haresh and Zhang, Gaoqing, CECL: Timely Loan Loss Provisioning and Bank Regulation (September 6, 2020). Available at SSRN: https://ssrn.com/abstract=3523321 or http://dx.doi.org/10.2139/ssrn.3523321

Lucas Mahieux (Contact Author)

Tilburg University - Tilburg University School of Economics and Management ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Haresh Sapra

Booth School of Business, University of Chicago ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

Gaoqing Zhang

University of Minnesota ( email )

321 19th Avenue South
Minneapolis, MN 55455
United States

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