Financial Regulatory Forum

Global accounting rule-setter proposes quicker booking of bad loans

By Reuters Staff
November 5, 2009

By Huw Jones
LONDON, Nov 5 (Reuters) – A global accounting standard setter published on Thursday a second leg of proposals to replace its fair value rule that was criticised by policymakers for amplifying the credit crunch.

The latest draft from the International Accounting Standards Board (IASB), which sets accounting rules used in over 100 countries, including Europe, looks at how banks and other companies book losses on financial instruments such as loans and corporate bonds.

The change, likely to have a big impact when it takes effect, would let lenders book losses from bad loans more quickly.

Roughly two-thirds of the losses banks are grappling with come from loans turning sour.

Under current rules, losses can only be booked when they are incurred, such as in a default or bankruptcy.

This is to stop abuses such as companies building up hidden provisions for padding out poor earnings, known as the cookie jar effect.

The reform of IAS 39 rule follows calls from the G20 group of countries for a more forward-looking way of booking losses, sparking concerns among accountants that an independent standard setter is bowing to political pressure.

The G20 meeets in St Andrews, Scotland, on Friday and Saturday to review progress on pledges such as accounting changes and other financial reforms aimed at applying lessons from the credit crunch.

The IASB’s latest proposal will allow banks to take swift action on bad loans, a change policymakers hope will give them more time to make adequate provisions and lessen the need for the huge taxpayer-funded bailouts seen in the financial crisis.

“Therefore under the proposals, a provision against credit losses would be built up over the life of the financial asset. Extensive disclosure requirements would provide investors with an understanding of the loss estimates that an entity judges necessary,” the IASB said.

Accountants said the challenges of switching to a more forward-looking method of booking losses should not be underestimated and must not confuse investors.

“In exploring the case for change, it will be important to consider not only the practicalities of implementation but also whether the advantages of an approach based on expected cash flows outweigh the disadvantages,” said Nigel Sleigh-Johnson, head of financial reporting faculty at the Institute of Chartered Accountants (ICAEW) in England and Wales.

The IASB said it acknowledged the challenges and had therefore decided on a long consultation period, until end of June 2010. The change would not become mandatory until about 2013.

BREATHING SPACE
The first leg of reform to IAS 39 is due to take effect shortly, in line with a G20 deadline that would allow banks and insurers to apply it to their 2009 annual reports.

It simplifies how banks and insurers classify which financial instruments must be valued at cost and which must be valued at the going market rate, known as marking to market.

Mandatory marking to market of some assets has forced banks to make huge writedowns in the credit crunch as some instruments like mortgage-backed securities sank in value or even became untradable.

The change that will soon take effect gives banks more breathing space than envisaged in the draft proposal published in July.

The IASB said it has listened carefully to stakeholders during its consultation. The latest amendments may partly deflect French criticism that the July proposal did not go far enough to help banks.

It will only cover the classificiation of instruments that are assets, leaving out liabilities until late 2010.

This delay should make a big difference for banks as many of the concerns in Europe centred on fears that more liabilities would have to be marked to market. Most valuations of liabilities are currently done at cost.

The final change also introduces more flexibility into how securitised assets are valued, with banks being allowed to take the underlying pool of assets more into account, thus allowing less senior tranches to be valued at cost.

Accountants said the change may have little immediate effect, however.

“Banks and insurers won’t be able to implement this for the end of 2009 even if it’s available. The number of organisations who might want to take advantage of it will be very small indeed,” said Michael Izza, chief executive of ICAEW.

The changes to internal systems and the risks for making mistakes this raises with only a few weeks left to compile the 2009 annual report will deter most firms, Izza said.

“It’s just putting another variable into a complex mix. It has to be audited as well,” he said.

The IASB is due to publish the third and final leg of its IAS 39 reform — covering hedge funds –at the turn of the year.

(Reporting by Huw Jones; Editing by Victoria Main)
((Reuters messaging: huw.jones.reuters.com@reuters.net; + 44 207 542 3326; huw.jones@thomsonreuters.com))

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