Benefits and Consequences of CECL-Adoption During COVID-19

The current expected credit loss (CECL) accounting model, which came into effect in 2020 in the United States, aims to address banks’ procyclical behavior and the delayed recognition of loan loss provisions (LLPs) experienced under the incurred credit loss model. Starting from 2020, major CECL-adopting banks initially increased LLPs, but quickly made large reversals in 2021, and then increased LLPs again in 2022, indicating procyclicality and contradicting the intended CECL purpose, which is for banks to build up long-term stable reserves. We explore this unexpected phenomenon by studying the consequences of adopting CECL and potential motivations for banks’ short-termism in building and releasing LLPs under the new accounting policy. Using a sample of U.S. Bank Holding Companies, we document that CECL-adopters exhibit increased volatility in LLPs and allowances for loan loss, report timelier and more valid LLPs, and show greater earnings response coefficients than non-CECL-adopters. However, we find that banks’ rapid LLP reversals in 2021 may have been motivated by opportunistic earnings management incentives. Our findings suggest that while the CECL model was intended to foster counter-cyclical and timelier loan loss provisioning, banks could have exploited its flexibility in LLP estimation for managerial opportunism, resulting in challenges for the policy intended to reduce banks’ procyclical behavior.