Still "Too Much, Too Late": Provisioning for Expected Loan Losses

The new accounting standards of IFRS 9 and U.S. GAAP adopt the expected loss (EL) approach for loan loss recognition. We investigate the effect of the EL approach on bank loan supply and stability. When a bank is unable to anticipate a downturn in the business cycle, it ends up recognizing the bulk of expected losses after the arrival of a contraction. This aggravates lending procyclicality and can potentially worsen bank stability. We develop a dynamic model of a bank to quantitatively assess these effects and show that they are economically significant.