New disclosures on expected credit loss: effects on Banking credit risk and its links with portfolio specialization

Abstract

Our study analyzes the information content of provisions in the expected credit loss (ECL) model in four credit segments: corporates, SMEs, institutions and households of European banks. Using data from the Prudential Relevance Report (Pillar 3) from 2019 to 2022, we assess the power of these provisions as anticipators of total, idiosyncratic, and systematic risks. The findings indicate that, for corporates and SMEs, Stage 2 provisions significantly influence total and idiosyncratic risks, reflecting the effectiveness of the ECL model in anticipating risk increases in these segments. In contrast, in the institutions portfolio segment we found no significance in relation to any of the risks, probably due to their lower risk profiles. Finally, for the households segment, Stage 1 provisions indicate an ability to anticipate short-term risks, while the variability and impact of long-term risks make them more difficult to predict, resulting in lower Stage 2 provisions. Our study makes an interesting contribution to the literature, as banks have to produce new disclosures regarding credit portfolio composition, which is valuable to differentiate portfolio segments’ provisioning practices and risk profiles, for both the supervisory bodies and bank management. The clients of the financial institutions and the whole financial system are expected to benefit from this higher level of information, which will lead to higher stability.

Peer Reviewed

Postprint (author's final draft)