Abstract
We study the impact of Current Expected Credit Loss (CECL) standards on various metrics, measuring the timing, level and volatility of CECL reserves in comparison to existing GAAP rules using historical industry-level bank data. We find that CECL standards could significantly increase the reserves set for loan losses. The impact would be larger for longer maturity exposures, such as 30-year residential mortgages. In addition to expected life of loan estimation, we analyze the relative importance of other CECL parameters such as Reasonable & Supportable period, the speed of mean reversion and longer-term charge off rates. Our study covers two underlying assumptions. Initially, CECL impact is simulated under perfect foresight assumption where the loss forecasts and macroeconomic projections assumed be very accurate. Then we relax this assumption and build biases in our loss forecasting capability. Our analysis show that CECL could bring in pro-cyclical variations in reserve setting which could exacerbate a downturn by limiting the availability of credit and loan growth.
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