The Effect of Forward-looking Criteria and IFRS on the Informativeness of Banks' Loan Loss Allowances: Evidence from Korea

This study analyses how forward-looking criteria (FLC) and International Financial Reporting Standards (IFRS), as well as changes in accounting principles, affect the informativeness of banks' loan loss allowances. The results indicate that although the relationship between non-performing loans and loan loss allowances strengthened after the application of FLC, the relationship between non-performing loans and loan loss allowances weakened and that between net charge-offs and loan loss allowances strengthened after the application of IFRS, presumably because banks delayed the reflection of insolvent loans on loan loss allowances in the latter case. Moreover, the introduction of IFRS did not improve the ability to predict the future charge-off scale using loan loss allowances, referred to as the 'informativeness of loan loss allowances'. This result occurred because IFRS's incurred loss model does not incorporate the impact of macroeconomic situations into loan loss allowances in the early stage, although it does enhance the accuracy of loan loss allowances. By exploring the effect of accounting principles on the determinants of loan loss allowances, this study has implications for the assessment of loan loss allowances, capital adequacy and asset quality for stakeholders such as depositors, creditors, capital markets and financial supervisory authorities.