Revolving bank losses and capital under loss models

Staff Work Paper No. 1,013

By Mahmoud Fatouh and Simone Giansante

We model the evolution of bank loan portfolios to assess the impact of IFRS 9 and US GAAP model loss (ECL) on the cycle of bad loans, loan provisions (LLPs) and bank capital , based on the loss model of IAS 39. We focus on the interaction between changes in LLPs’ payments (the flow path) and shares (the of goods) under ECL. Our results show that, when GDP growth does not show high volatility, the ECL model moderates the impact of bad debt on profits and capital, reducing the procyclicality of capital and leverage ratios, especially under US GAAP. However, when GDP growth increases, large differences in lifetime potential deficits (PDs) between booms and busts lead to a significant increase in LLPs in deep recessions, as seen for American banks during the Covid-19 crisis. GDP growth increases the use of capital and leverage, with a greater drop in both ratios under US GAAP, compared to IAS 39. IFRS 9 ECL shows a decrease in sensitivity to lifetime PDs varies due to the existence of loan conditions, and therefore can reduce the model of capital and rate, even if GDP deficit.

Revolving bank losses and capital under loss models

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