How do bank managers forecast the future in the shadow of the past? An examination of expected credit losses under IFRS 9

Abstract

One of the most significant changes under IFRS 9 is the shift to considering and incorporating forward-looking information to forecast expected credit losses (ECL). This study aims to understand how bank managers incorporate forward-looking information, such as future economic projections, in assessing significant credit risk deterioration, and how bank managers evaluate the reasonableness of different forecast horizons in order to project lifetime ECL. We conducted an experiment with 72 bank managers. Our results reveal that bank managers are reluctant to incorporate good news when historical information indicates a high default risk and potentially large credit loss, and that their ECL estimates are influenced by the upward or downward shift in the forecasted losses. We view these results as consistent with the unconditional conservatism of the new ECL model.