New international accounting rules are likely to lead to banks taking higher loan loss provisions, Fitch Ratings says in a new report.
The rating agency says that banks’ impairment reserves “are likely to rise as a result of new accounting rules published yesterday that introduce an expected-loss approach for loan-loss provisioning.”
The International Accounting Standards Board (IASB) issued its final standard on financial instruments yesterday after five years of consultation. “During the financial crisis, the delayed recognition of credit losses on loans (and other financial instruments) was identified as a weakness in existing accounting standards,” notes the IASB. Therefore, it has introduced “a new, expected-loss impairment model that will require more timely recognition of expected credit losses.”
The new accounting standard, which is due to take effect Jan. 1 2018, is intended to be more forward-looking, Fitch notes, “allowing management to factor forecast changes in conditions into the impairment charge. It will make provisioning more prudent (it will increase impairments) but at the cost of additional complexity.” And, it says that implementation of the new standards “will involve considerable judgement and add to the degree of subjectivity already inherent in loan loss provisions.”
That said, Fitch also says that it believes the increased disclosure proposed in the new standard “is essential to improve transparency and will benefit users, particularly when combined with the take-up of recommendations around credit risk reporting by the Enhanced Disclosure Task Force.”
However, it notes that differences between U.S. rules and international rules will mean that it will still be difficult to make meaningful comparisons between provisions reported by banks following the different standards.
Fitch also points out that the additional provisioning will not necessarily hit regulatory capital for all banks, as technical differences will remain in the financial statements and regulatory reporting definitions of expected losses. It suggests that the effect of the higher provisions will be moderated for banks that use the internal approach to calculating regulatory capital; whereas the impact will be more directly felt by banks using the Basel standardized approach to calculating their regulatory capital.
Assuming that the new accounting rules take effect as planned in 2018, Fitch says that, since the Basel III reforms have already introduced significant new regulatory buffers, “that should enable banks to better weather periods of higher loan losses that emerge.”