CECL: Timely Loan Loss Provisioning and Bank Regulation

Date
2020-08-14
Authors
Mahieux, Lucas
Sapra, Haresh
Zhang, Gaoqing
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Abstract
We investigate how provisioning models affect bank regulation. We consider an accuracy vs. timeliness trade-o¤ between two provisioning models, an incurred loss model (IL) and a current expected credit loss model (CECL). Relative to IL, CECL improves efficiency as it allows for timely intervention to curb inefficient ex post asset-substitution, despite that the early information CECL recognizes 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 model therefore calls for better coordination between bank regulators and accounting standard setters.
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Cecl, Expected Loss Model, Incurred Loss Model, Capital Requirements, Loan Loss Provisioning, Real Effects, Banking Regulation
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