Prior research finds that banks reduce loan originations during recessions to mitigate the potential for their regulatory capital to become inadequate. 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 recognition of loan losses to recessions when the losses become incurred, probable, and reasonably estimable. Responding to this concern, the FASB issued Accounting Standards Update 2016-13, which requires large public (small public and private) banks to accrue for loan losses using the current expected credit loss (CECL) approach starting in 2020 (2023). Contrary to this concern, we hypothesize and find that banks that adopted CECL prior to the COVID-19 pandemic reduced loan growth during the accompanying recession more than other banks. We further predict and find that this effect is stronger (weaker) for adopting banks with low regulatory capital (with low heterogenous loans or that recorded large increases in credit loss allowances upon their initial adoption of CECL). We also find that adopting banks increased their loan loss provisions during the recession more than other banks. Our results are consistent with the CECL approach increasing banks’ lending procyclicality.
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