Limitations of Implementing an Expected Credit Loss Model

Current Expected Credit Losses (CECL) Standard and Banks' Information Production

“…Ertan [2021] shows that banks that adopted ECL reduce credit supply to small and medium-sized enterprises due to the difficulty in provisioning for more opaque borrowers. Bischof et al [2021a] find that banks strategically adjust the internal ratings of their borrowers to minimize loan loss provisions. While these studies of IFRS 9 may provide some insights for the expected effects of CECL adoption, their findings may not be replicated under CECL adoption because ECL differs from CECL in several ways.…”

“…The most notable difference is that under ECL, loans are classified into three stages based on credit quality, and losses are estimated for different horizons depending on the stage, whereas under CECL losses are estimated over the lifetime of the loan for all loans. In particular, under ECL, for loans classified as stage 1, which includes all new loans, credit losses are estimated over a one-year horizon, resulting in less provisions than under CECL [Lopez-Espinosa et al, 2021, Bischof et al, 2021a.…”