Bank discretionary provisioning and systemic risk under impairment accounting standard reforms

To reduce the procyclicality of the incurred loss (IL) model revealed during the global financial crisis, the International Accounting Standards Board introduced the new impairment standard centered on expected loss (EL) model. This paper develops an economic model with an interbank market to assess how forward-looking provisioning under EL affects systemic risk relative to IL. Simulations show that for small shocks, EL reduces systemic risk when banks underestimate or correctly estimate losses, but can increase risk when losses are overestimated, due to excessive capital depletion. As shocks intensify, EL strengthens resilience by inducing banks to build larger capital buffers ahead of crises. Analytical findings further indicate that banks provision more aggressively under larger shocks or weaker capital positions. Overall, the risk-mitigating benefits of EL depend on both shock magnitude and banks’ discretionary bias, implying the need for stronger regulatory oversight alongside risk forecasting.