The Value Relevance of Overlays

The COVID-19 pandemic and its successive lockdowns and restrictions have had severe economic consequences. The measurement of Expected Credit Losses (ECL) under the International Financial Reporting Standard (IFRS) 9 Financial Instruments is a complicated process, made more challenging by the lack of comparable data from past events. As a result, ECL models were unable to accurately predict these losses. To address this issue, entities turned to overlays, adjustments made outside of the ECL models, as a means to try and mitigate the problem (PwC, 2020). The main aim of this paper is to evaluate the value relevance of overlays for investors and to examine whether they are significant in predicting earnings and operating cash flows (OCF). To achieve this, the study employed the price regression model based on Ohlson's (1995) framework and models based on Dhaliwal et al.'s (1999) methodology to assess the predictiveness of earnings and OCF. The study used a sample of 36 European Union banks and analysed data from 2020 and 2021, which was the period when the pandemic had the most severe impact. The findings revealed that while overlays had a negative value relevance, they did not significantly contribute to predict earnings and OCF.