The New Era of Expected Credit Loss Provisioning

Benjamin H Cohen and Gerald A Edwards, Jr

The global financial crisis (GFC) of 2007–9 highlighted the systemic costs of delayed recognition of credit losses by banks and other lenders. Pre-crisis, application of the prevailing standards was seen as having prevented banks from provisioning appropriately for credit losses likely to arise from emerging risks. These delays resulted in the recognition of credit losses that were widely regarded as “too little, too late”. Furthermore, questions were raised about whether provisioning models, along with the effect of provisioning on regulatory capital levels, contributed to procyclicality by spurring excessive lending during the boom and forcing a sharp reduction in the subsequent bust.

Following the crisis, the G20 leaders, investors, regulatory bodies and prudential authorities called for action by accounting standard setters to improve loan-loss provisioning standards and practices. In response, the International Accounting Standards Board (IASB) in 2014 published IFRS 9, “Financial Instruments”, which includes a new standard for loan-loss provisioning based on “expected credit losses” (ECL) (IASB 2014a).11 IFRS 9 also includes new rules for classification and measurement of

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