Spillover Effects of Expected Credit Losses Model Implementations

Banks’ mandatory switch from an incurred credit loss model (IL) to an expected credit losses model (EL) in certain jurisdictions can affect loan pricing and securitization in foreign markets. Comparing U.S. banks with IFRS subsidiaries to U.S. domestic banks, we find that the former charge higher loan spreads after starting to shift to EL, especially for those with greater exposure to IFRS countries. This pricing effect varies predictably with loan demand elasticity. Second, banks are more likely to shift institutional facilities off the balance sheet through securitization while increasing the spread on pro-rata facilities, consistent with a substitutional effect. Both the pricing effect and substitutional effect induce more risk-taking behaviors by dependent borrowers of U.S. banks with IFRS subsidiaries. Our results shed light on the unintended consequences of EL implementation