Did CECL and IFRS 9 Fix the Procyclicality Problem?
Modern reporting standards for expected credit losses are, as anticipated, more volatile than the previous incurred-loss approach. But the key question is whether they have also yielded more accurate credit loss forecasts that allow financial institutions to build loss reserves proactively, improving their ability to bounce back from recessions.
Article Tony Hughes
Now that we've experienced a pandemic-driven recession, it seems as good a time as any to assess whether the CECL and IFRS 9 reporting standards for expected credit losses (ECL) have had their desired impact. After all, these standards were expected to yield a more proactive loss-accounting system that would enable financial institutions to improve forecasting and build up loss reserves that could counteract the impact of any recession.
One of the problems with the incurred loss approach for credit losses, which was in place prior to CECL and IFRS 9, was that it was too procyclical. This resulted in firms not being able to develop proper loss reserves prior to the beginning of a recession, which, in turn, meant that they could not free up funds to support an earlier resumption of lending growth.
Procyclicality and volatility were two of the key concerns of loss accounting critics prior to the launch of CECL and IFRS 9. But in the aftermath of post-implementation recessions (there have actually been two in the UK,) it is now possible to address whether ECL is truly fit for purpose.
