IASB plans for better loan-loss accounting to shake-up banks

New proposals are aimed at exposing potential credit losses from the beginning and are a response to accounting weaknesses identified during the GFC

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A decision by the International Accounting Standards Board (IASB) to revise the way loan-loss provisioning is undertaken could have significant ramifications for banks and the financial services market worldwide.

The IASB published a revised set of proposals on 7 March which it claims will recognise expected credit losses on all financial instruments in a more timely, efficient way, avoiding the transparency issues faced during the global financial crisis (GFC). Expected credit losses are an estimate of losses around lending activities such as payment defaults, a catalyst for the recent GFC.

The proposals are based on the expected credit loss model previously agreed between the IASB and the US Financial Accounting Standards Board (FASB) and follow repeated requests from the G20 economic leaders group and Financial Crisis Advisory Group to develop a more forward-looking impairment model that makes it easier to see losses on financial assets and commitments to extend credit earlier.

The changes are in direct response to weaknesses identified in accounting standards during the GFC, IASB stated. The complexity of current accounting practices relating to loans and credit have also been singled out as an area of concern for banks worldwide.

But critics argue the plans could put unnecessary strain on the banks, while pointing out the IASB and the FASB have failed to reach a commitment and now offer up separate proposals, raising the risk of confusion.

In a report by Reuters and the <i>West Australian</i>, Ernst & Young partner Tony Clifford claimed that because the changes were based on forecasts and estimates, they will inevitably result in more volatility in provisioning.

Previously, credit and loan providers didn’t have to recognise such losses until a threshold was reached or a default occurred. The new proposals state expected credit losses would now be recognised at the point which financial instruments are originated or purchased.

“We believe the model leads to a more timely recognition of credit losses. At the same time, it avoids excessive front-loading of losses, which we think would not properly reflect economic reality,” IASB chairman Hans Hoogervorst said.

“We look forward to receiving feedback on these proposals and moving swiftly to finalise this important project, consistent with repeated requests of the G20.”

The Financial Instruments: Expected Credit Losses will be open for public consultation until 5 July 2013 and is available here.

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