Does the Current Expected Credit Loss Approach Decrease the Procyclicality of Banks’ Lending? Evidence from the COVID-19 Recession

In the wake of the financial crisis, policymakers expressed the concern that banks’ use of the incurred loss model exacerbates their lending procyclicality by delaying the loan loss recognition to recessions. Responding to this concern, the FASB issued Accounting Standards Update 2016-13, which requires large public banks to accrue for loan losses using the current expected credit loss (CECL) approach starting in 2020. Contrary to this concern, we hypothesize and find that banks that adopted CECL prior to the COVID-19 pandemic increased loan loss provisions and reduced loan growth during the accompanying recession more than other banks. The procyclical contraction of lending is stronger for adopting banks with low regulatory capital and low initial CECL adoption impacts and is primarily driven by commercial loans. Lastly, we find that counties for which CECL-adopting banks have higher market share experience larger increases in unemployment rates during the recession and slower subsequent recoveries.