Effects of ASU 2016-13 and COVID-19 on banks' loan loss allowances

Abstract

Accounting Standards Update (ASU) 2016–13 substantially changed the FASB's previous accounting guidance in SFAS 114 for credit loss estimation with the objective of making recognition more timely. We examine the effect of the initial adoption of ASU 2016–13 on January 1, 2020, on banks' loan loss allowances and its subsequent effect on banks' provision accruals over the first three quarters of 2020 during the COVID-19 pandemic when economic conditions changed rapidly. After controlling for bank size and other factors previously found to be associated with provisions, we find that banks adopting ASU 2016–13 made significantly larger provisions than SFAS 114 banks in Quarter 1 but not in Quarter 2. However, as economic conditions improved markedly in Quarter 3, we find a reversal in that the ASU 2016–13 banks reported significantly smaller mean provisions than the SFAS 114 banks. These results provide preliminary evidence that ASU 2016–13 has achieved its objective of making allowances more sensitive to changing economic conditions.