Market Reaction to the Expected Loss Model in Banks

Abstract

We investigate how investors perceive the adoption of the expected-loss model (ELM) for impairment incorporated in IFRS 9. Using a sample of European listed banks covering the period of the standard-setting process of IFRS 9, we examine whether the market perceives the new regulation to increase shareholder wealth. First, we document a positive market reaction to the ELM adoption events. Second, we find that investors perceive that the potential benefits of ELM are more pronounced for larger banks, banks with lower profitability and higher systemic risk, and for those that received a public bailout and with more positively skewed returns. Overall, these results support a “monitoring” channel suggesting that ELM may lead to greater bank transparency and more effective market discipline, fundamental for improving financial stability.