The Credit Risk Relevance of Bank Loan Loss Provisions Under IFRS 9: Early Evidence
Since the first fiscal quarter of 2018, banks have implemented a new expected credit loss (ECL) model to estimate loan loss provisions (LLPs) under International Financial Reporting Standard (IFRS) 9, which replaces the incurred loss model under International Accounting Standard (IAS) 39. The major difference in provisioning approaches between the two models is the incorporation of forward looking information under the IFRS 9 ECL model. This paper examines whether IFRS 9 improves the credit risk relevance of LLPs for credit default swap (CDS) market participants. The findings suggest that LLPs under IFRS 9 are marginally more credit risk relevant than under IAS 39. Moreover, LLPs under IFRS 9, to a greater extent than under the IAS 39 regime, affect the pricing of credit risk for longer CDS maturities. This finding is consistent with the IFRS 9 ECL model that provides a more forward looking measure of credit risk. Finally, cross sectional tests highlight the importance of institutional features that play a significant role in the relevance of accounting information. To address endogeneity concerns, I implement a dynamic panel data two step model and a two stage instrumental variable approach. These alternative tests confirm the enhancement of the credit risk relevance of LLPs following the adoption of IFRS 9.