Unrecognized Expected Credit Losses and Bank Share Prices

Journal of Accounting Research, Volume 59, Issue 3

Posted: 25 Jun 2021

See all articles by Barrett Wheeler

Barrett Wheeler

Tulane University - Accounting & Taxation

Multiple version iconThere are 2 versions of this paper

Date Written: June 1, 2021

Abstract

Accounting for credit losses under U.S. GAAP is transitioning from an incurred to an expected loss model. The model change was motivated by concerns that reporting only incurred losses does not provide investors with sufficient and timely information about banks’ credit risk. In this paper, I develop a measure of lifetime expected credit losses using vintage analysis to examine whether stock prices reflect information about unrecognized expected credit losses in an incurred loss regime. Consistent with investors being able to obtain information about expected losses that are not recognized in the financial statements, I find that unrecognized expected credit losses are negatively associated with bank stock prices. The pricing of these losses is stronger for larger banks, consistent with lower costs of obtaining this information for banks with better information environments. I also find that recorded allowances were less than estimated expected losses, on average, consistent with concerns that implementing the expected loss model will adversely impact regulatory capital adequacy.

Keywords: banking; allowance for loan losses; loan loss provisions; incurred loss model; current expected credit loss model; standard setting

JEL Classification: G21, M41

Suggested Citation

Wheeler, Barrett, Unrecognized Expected Credit Losses and Bank Share Prices (June 1, 2021). Journal of Accounting Research, Volume 59, Issue 3, Available at SSRN: https://ssrn.com/abstract=3867752

Barrett Wheeler (Contact Author)

Tulane University - Accounting & Taxation ( email )

United States

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