The Impact of IFRS 9 on Banks’ Loan Loss Provisioning

Abstract

IFRS 9 introduced a new impairment model based on expected credit losses (ECL) rather than incurred losses to better reflect changes in the credit quality of financial instruments. This paper examines the impact of the ECL model on the predictability of loan loss provisions (LLP) and potential consequences on market discipline. Specifically, I first investigate whether the association between recognized loan loss provisions and objective determinants of the incurred loss model (i.e., changes in non-performing loans and the level of non-performing loans) decreases after the introduction of IFRS 9. Next, I examine whether the arguably less objective LLP under IFRS 9 obscure market participants' ability to monitor the banks’ risk-taking incentives. The empirical findings suggest a decrease in the association between loan loss provisions and the determinants of the incurred loss model in the post-IFRS 9 period, i.e., LLP are based less on objective determinants after IFRS adoption. Furthermore, I find a decrease in the sensitivity of leverage to changes in risk in the post-adoption period of IFRS 9, indicating an attenuated market discipline over risk-taking of banks. The results are mainly driven by banks in countries that allow more smoothing through loan loss provisions as opposed to banks in countries that are more forward-looking. In contrast, I find no changes in the determinants of LLP and market discipline for the benchmark sample of U.S. banks, which were not subject to the same accounting change during the sample period.