Prudential Regulation under CECL: Cycle Turns and Reward/Risk Combinations

48 Pages Posted: 13 Jan 2021 Last revised: 30 Jun 2021

See all articles by Tong Lu

Tong Lu

University of Houston

Lanyi Zhang

University of Houston - Downtown

Date Written: June 29, 2021

Abstract

This study investigates the implications of the current expected credit losses
(CECL) model for capital requirements in prudential regulation, and demonstrates
the interaction between the dual role (valuation role and regulatory role)
of CECL. In contrast with the conventional wisdom that stresses only credit supply
to the real sector, the risk attribute of loan portfolios, and countercyclical
capital requirements, we highlight the balance between two functions of banks
(both credit supply to the real sector and liquidity provision to households) and
derive the optimal capital requirements under CECL that are contingent on (1)
the combination of reward and risk attributes of loan portfolios, and (2) cycle
turns.

Keywords: liquidity provision; reward and risk; cycle turns; CECL; valuation; regulation.

JEL Classification: M41, G21, G28

Suggested Citation

Lu, Tong and Zhang, Lanyi, Prudential Regulation under CECL: Cycle Turns and Reward/Risk Combinations (June 29, 2021). Available at SSRN: https://ssrn.com/abstract=3735135 or http://dx.doi.org/10.2139/ssrn.3735135

Tong Lu (Contact Author)

University of Houston ( email )

4800 Calhoun Road
Houston, TX 77204
United States

Lanyi Zhang

University of Houston - Downtown ( email )

Houston, TX 77002
United States
7132215062 (Phone)

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