WORKING PAPERS
I investigate the dynamic real effects of the new Current Expected Credit Loss Model (CECL) on banks credit availability and cyclicality. Specifically, I construct a loan portfolio migration model to examine how the timing difference of provisioning between CECL and the Incurred Loss Model (ICL) affects bank lending, capital and profit during both economic upturns and downturns. Using a set of parameters of U.S. mortgage loans, I calibrate the model and find that loan loss allowances under CECL are significantly higher at all times. Under CECL, the bank holds less capital, earns less profit and issues considerably less lending both in expansion and contraction. Although higher reserves under CECL at loan origination can help banks better prepare for future losses, they also impose additional opportunity costs on lending. More importantly, after an unexpected contraction arrives, forward-looking provisions of CECL surge more dramatically than ICL, further hinder lending and profitability. My results suggest that bank lending is more pro-cyclical under CECL than ICL. Paradoxically, CECL’s ex ante provisioning of loan losses limits credit creation and aggravates procyclicality, which goes against its intended purpose.
Joint Impact of Prudential Regulation and Loan-Loss Reserving on Crisis Lending - with Karthik Balakrishnan and Shiva Sivaramakrishnan
Revise and Resubmit at The Accounting Review
We provide evidence that bank capitalization and loan-loss reserving jointly determine pro-cyclicality in lending. Using the Global Financial Crisis of 2007-2009 as our context, we show while banks with low regulatory capital buffers (Low RCB banks) reduce lending because of the capital-crunch effect, those with high regulatory capital buffers (High RCB banks) reduce lending during the crisis. Moreover, for High RCB banks, Crisis-lending is inversely related to the size of the buffer. This result is consistent with the notion that High RCB banks have higher risk exposures in their loan portfolios heading into the Crisis and are faced with great unexpected losses during the Crisis. Therefore, these bank cut back on lending more. Our evidence also suggests that adequate loan-loss reserving heading into the crisis mitigates this pro-cyclicality effect for both types of banks. Our analysis provides new insight into the usability of capital buffers during downturns.
WORK IN PROGRESS
The Anticipatory Effects of CECL Implementation - with Hailey Ballew and Shiva Sivaramakrishnan
The Impact of Economic Cycles on Firm Disclosure - with Ioannis Floro, Rustam Zufarov and Shiva Sivaramakrishnan