Switching from Incurred to Expected Loan Loss Provisioning: Early Evidence

76 Pages Posted: 28 May 2020

See all articles by Germán López-Espinosa

Germán López-Espinosa

School of Economics - University of Navarra and IESE Business School

Gaizka Ormazabal

University of Navarra, IESE Business School; European Corporate Governance Institute (ECGI)

Yuki Sakasai

IESE Business School

Multiple version iconThere are 3 versions of this paper

Date Written: May 2020

Abstract

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. To corroborate that the switch to ECL provisioning results in more information to assess bank risk, we analyze the market reaction to disclosures on the first-time impact of the accounting change; we find that a higher impact on loan loss allowances elicits lower stock returns, higher changes in CDS spreads, and higher changes in bid-ask spreads. Critically, these patterns are most pronounced when credit conditions deteriorate. Finally, we also find evidence that, as credit conditions worsen, the rule change induces an increase in provisions and a contraction of credit. 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.

Keywords: bank accounting, expected credit losses, loan loss provision

JEL Classification: G21, M41

Suggested Citation

López-Espinosa, Germán and Ormazabal, Gaizka and Sakasai, Yuki, Switching from Incurred to Expected Loan Loss Provisioning: Early Evidence (May 2020). CEPR Discussion Paper No. DP14803, Available at SSRN: https://ssrn.com/abstract=3612872

Germán López-Espinosa (Contact Author)

School of Economics - University of Navarra and IESE Business School ( email )

Navarra
Spain
+34 948425600 (Phone)
+34 948425626 (Fax)

HOME PAGE: http://https://sites.google.com/site/germanlopezespinosa/

Gaizka Ormazabal

University of Navarra, IESE Business School ( email )

Avenida Pearson 21
Barcelona, 08034
Spain

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Yuki Sakasai

IESE Business School ( email )

Avenida Pearson 21
Barcelona, 08034
Spain

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