LO 73.1: Describe the reasons to provision for expected credit losses.

LO 73.1: Describe the reasons to provision for expected credit losses.
Historical evidence suggests that loan interest rates were determined in unstable market conditions and, therefore, did not always account for all credit risks. As a result, forward- looking provisions should be made at the same time as loan origination.
The requirement for banks to set aside funds as capital reserves is unlikely to reduce a banks lending activities during strong economic periods. The result may be excessive lending by banks. Therefore, by provisioning for expected credit losses (ECL), a more accurate cost of lending may be determined (which may ultimately control the amount of lending).
The concept of procyclicality refers to being positively correlated with the overall state of the economy. Reducing the procyclicality of bank lending is likely to occur with earlier provisioning for loan losses. Increased (decreased) regulatory requirements pertaining to provisions tend to reduce (increase) the level of bank lending.
The use of forward-looking provisions essentially results in the earlier recording of loan losses, which may be beneficial to financial statement users from the perspective of conservatism in a banks reporting of earnings.
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Topic 73 Cross Reference to GARP Assigned Reading – Cohen and Edwards
IASB a n d FASB St a n d a r d s

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