Accounting Measurement, Prudential Regulation, and the Real Effects of IFRS 9 on Non-Performing Loans

We examine how the interaction between accounting measurement and prudential regulation shapes banks’ loss recognition and resolution strategies for non-performing loans (NPLs). We exploit the adoption of IFRS 9, which introduced forward-looking expected credit loss measurement but allowed banks to (i) recognize higher credit loss allowances at transition directly in retained earnings and (ii) phase in their effect on regulatory capital. We argue that these transition features gave banks both the ability and the incentive to write down and divest NPLs—whose reported amounts had previously been shielded from market prices on balance sheets—thereby overcoming frictions in the secondary NPL market. Consistent with this prediction, we find that the IFRS 9 transition triggered higher impairment charges on NPLs and, subsequently, greater NPL sales, improving banks’ balance sheet quality. Our findings highlight how the interaction of accounting measurement and prudential regulation shapes banks’ economic decisions.