The International Accounting Standards Board (IASB) – the organization that sets accounting standards for much of the world outside of the U.S. – last week issued revised final rules that give banks greater discretion in writing down loans more quickly than under existing rules. The implications of the new rules known as “IFRS 9,” which will become effective on January 1, 2018, are the subject of debate among banks, regulators and commentators, as discussed recently by Dealbook and the Economist, among others. Additionally, the organization that sets U.S. accounting standards, the Financial Accounting Standards Board (FASB), is expected to issue similar, but somewhat different, rules later this year.
The revised IASB rules will require banks to record loan losses based on the bank’s forecast for future losses, rather than based on actual losses incurred, as is required under the current rules. The revised IASB rules will require a bank to immediately incur an amount of loss for a loan based on the probability of that loss being incurred in the following twelve months, and also require the bank to adjust its loan loss reserves as the bank’s forecast might change. The new rules will likely result in greater write downs than are being recorded under the current rules – as much as 50%, by one estimate – and cause banks to hold more capital.
The new rules also give banks discretion to consider other factors in forming its loss forecast, which some argue will give banks greater ability to manipulate its forecast and reserves and, thus, its earnings. This could make earnings more difficult to compare against both prior periods and competitors’ earnings. Others argue that the new rules are more effective than the existing and more inflexible “incurred-loss” rules, which they say exacerbated the financial crisis by preventing banks from recording the full amount of its increasingly likely losses until those losses were actually incurred, which they say resulted in inaccurate financial reporting.
While FASB has also proposed moving toward an “expected loss” standard, its proposed rules will require all losses expected over the lifetime of a loan to be booked immediately. This would cause greater immediate write downs for companies observing FASB than for those observing IASB. The FASB and the IASB were unable to agree on a single approach.