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    FED Paper Examines Impact of Current Expected Credit Loss Standard

    August 09, 2019

    FED published a working paper that examines the accounting and economic impact of the Current Expected Credit Loss (CECL) standard. The paper presents a framework that captures a simple and relatively direct impact of CECL on credit availability. The CECL standard will soon replace the incurred loss method (ILM) for the recognition of credit losses in financial accounts. The resulting changes to the timing and magnitude of loss allowances will affect the regulatory capital of banks. As the date of implementation approaches, several commentators have raised concerns that the standard will have a “procyclical” impact, reducing lending in downturns. In contrast, the findings in this study suggest that CECL will modestly affect bank lending in a way that dampens fluctuations.

    The paper highlights that CECL results in earlier accumulation of allowances prior to recessions than the ILM. This feature of the standard encourages banks to deleverage and raise capital before credit conditions are at their tightest. However, CECL may also result in a larger accumulation of allowances around recessions, potentially encouraging banks to deleverage more. Accounting for both of these effects, CECL would have reduced lending in the lead up to the financial crisis and increased it during the recovery, modestly decreasing the volatility of lending growth. These conclusions are robust to a range of assumptions about banks’ foresight of losses and management of capital ratios. The framework presented in this paper does not incorporate potential effects of CECL on the composition of bank lending and loan pricing., which  could further reduce cyclicality. The analysis may overstate the magnitude of the impact of CECL to the extent that

    • Banks have significant discretion when modeling CECL allowance for credit losses
    • Banks are indifferent to the shorter-term shifts between allowances
    • Capital implied by CECL or the capital impact at banks subject to comprehensive capital analysis and review (CCAR) is roughly offset by reductions in the modeled stress losses

     

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    Keywords: Americas, US, Banking, Accounting, CECL, Regulatory Capital, Incurred Loss Method, CCAR, Research, IFRS 9, FED

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