Bank Loan Loss Accounting and Its Contracting Effects: The New Expected Loss Models

Abstract

As a result of the recent financial crisis, several key institutions urged the IASB and the FASB to re-evaluate their models for loan loss accounting and use more forward-looking information. The paper examines the principal features of the new expected loss approach, taking into account the tensions between accounting and prudential objectives with respect to credit losses. We discuss the rationales for the change introduced by IFRS 9 and explore the differences between the IASB and the FASB models. Based on the notions of accounting conservatism and earnings management, we discuss the potential consequences of the new models. While both the FASB and the IASB model are more conservative than the incurred loss approach, each portrays a different type of conservatism, whose ability to provide information will depend on the bank’s business model. We also argue that the differences in business models that prevail in different jurisdictions might help to explain the existence of two expected loss models. Besides, we identify new avenues for further research within the financial sector.