Processing forward-looking loan loss provisions: evidence from the adoption of the CECL model

Series: Working Papers. 2617.

Author: Daniel Dejuan-Bitria

Corporate finance

• Financial risks
• Credit
• Financial investment

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Processing forward-looking loan loss provisions: evidence from the adoption of the CECL model (1 MB)

Abstract

This paper examines the impact of the Current Expected Credit Loss (CECL) model on the efficiency with which equity investors process banks’ earnings announcements. A potential concern with CECL is that it increases the complexity of loan loss provisions. I examine whether this added complexity impairs investors’ ability to efficiently process earnings announcements. Using a difference-in-differences methodology, I find that CECL reduces investors’ processing efficiency during banks’ earnings announcements. The effect is stronger when provisions are driven by the origination of new loans. This finding is consistent with the idea that CECL introduces a timing mismatch between loss and revenue recognition—provisions for expected losses are recognized at loan origination while interest income accrues over the life of the loan—making it harder for investors to interpret the valuation implications of provisions. Collectively, my results show that equity investors face higher processing costs when interpreting banks’ earnings announcements under CECL.