As the COVID-19 pandemic spreads and the global economy continues to weaken, the credit risk of many borrowers is expected to increase. This would require banks to hold additional capital against these risks under new ‘expected credit losses’ (ECL) accounting standards. ECL accounting frameworks were introduced after the 2008 financial crisis in order to combat procyclical effects of the previous incurred loss models. These frameworks – IFRS 9, which is used by banks around the world, and CECL, which is namely applicable to US banks – now face their first challenge and are likely to act procyclical themselves.
The focus of this IIF Staff Paper – Modeling ECL during the COVID-19 pandemic: Providing flexibility to avoid procyclicality – is on how these new ECL standards work, how they introduce procyclicality under deteriorating credit conditions, and what actions and guidance regulators and accounting standard-setting bodies have issued to help avoid excessive procyclicality throughout the current crisis. The paper also argues that there is a risk of market fragmentation if respective competent authorities provide different guidance and guidance with differing granularity on how to respond to this crisis. The existing differences between IFRS 9 and CECL already add complexity for major banks that need to reconcile both approaches. It would be useful to analyze the impact of both frameworks on regulatory capital and whether there are significant differences due to the inherent variations in IFRS 9 and CECL.