DP13135 The Procyclicality of Expected Credit Loss Provisions

Author(s): Jorge Abad, Javier Suarez
Publication Date: August 2018
Keyword(s): credit loss allowances, expected credit losses, incurred losses, procyclicality, rating migrations
JEL(s): G21, G28, M41
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13135

The Great Recession has pushed accounting standards for banks' loan loss provisioning to shift from an incurred loss approach to an expected credit loss approach. IFRS 9 and the incoming update of US GAAP imply a more timely recognition of credit losses but also greater responsiveness to changes in aggregate conditions, which raises procyclicality concerns. This paper develops and calibrates a recursive ratings-migration model to assess the impact of different provisioning approaches on the cyclicality of banks' profits and regulatory capital. The model is used to analyze the effectiveness of potential policy responses to the procyclicality problem.