Expected Credit Loss Provisioning, Bank Capital Regulation, and Systemic Risk: Evidence from the Chinese Regulatory Context
Abstract
This study examines the effect of expected credit loss (ECL) provisioning on the ability of bank capital to mitigate systemic risk based on the Chinese regulatory context, where regulators emphasize the adequacy of loan loss provisions (LLPs) over their timeliness. We find that the ECL model increases LLP adequacy in Chinese banks, but offers no significant improvements in LLP timeliness and is accompanied by instances of manipulation. Despite these mixed first‐order effects, we find that the ECL model strengthens the effectiveness of capital in mitigating systemic risk. This effect is more pronounced when the ECL model improves LLP adequacy to a greater extent, and less so when LLPs, particularly those in stages 1 and 2, are subject to a high degree of manipulation. Our study demonstrates the limited effect of the ECL model on information quality in developing jurisdictions, while demonstrating its significantly positive impact on financial stability. These findings contribute to the International Accounting Standards Board's evaluation of the theoretical framework of the ECL model and the global implementation effects of IFRS 9, while also assisting banking authorities in assessing the impact of IFRS 9 on financial stability. The results should have particular relevance for countries with limited forward‐looking information, rules‐based provisioning frameworks, and weak enforcement.