Working Paper: CEPR ID: DP13135
Authors: Jorge Abad; Javier Suarez
Abstract: 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.
Keywords: credit loss allowances; expected credit losses; incurred losses; rating migrations; procyclicality
JEL Codes: G21; G28; M41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| ECL approach (C50) | larger impairment allowances (J14) |
| ECL approach (C50) | sharper decline in profits during recession (F44) |
| ECL approach (C50) | sharper decline in capital during recession (E22) |
| failure to anticipate economic turning points (E32) | more abrupt capital deterioration (G32) |
| introduction of countercyclical capital buffer (CCB) (G28) | mitigate procyclical effects of ECL (E32) |