The International Accounting Standards Board (IASB), whose rules are followed by all the UK’s major lenders, has set out a series of rule changes that will require banks to recognise losses far earlier, reports The Telegraph.
Under the current rules, banks are only required to account for a loss when it occurs or if they believe they could exceed a certain threshold. However, the new code would force lenders to recognise upfront all the losses they could have to take against a loan over its life as soon as their is evidence of any deterioration in its value.
The change is expected to answer criticisms that the current rules gives banks too much leeway on when and how much to take in provisions against their assets.
Any changes to the way banks account for losses could force them to raise more capital to meet the cost of provisioning against any new writedowns.
Tony Clifford, an international accounting specialist at Ernst & Young, said the rules would be likely to force banks to increase their provisions against losses. He described the proposed rule change as the single biggest change in accounting the banks have ever had to deal with.
“The increase in provision will vary by entity, and entities with shorter term and higher quality financial assets are less likely to be affected,” said Mr Clifford.
The new “expected loss” rule comes after several years of calls from senior regulators, including Sir Mervyn King, the Governor of the Bank of England, for banks to admit to the full scale of the losses on their balance sheets.
G20 leaders had called for an international agreement on accounting standards, but the IASB and its US counterpart, the Financial Standards Accounting Board, said last year that they had been unable to reach a deal.
“This is a big disappointment” said Andrew Vials at accountancy firm KPMG, who added that the hoped the two bodies could still agree a joint approach that would mean US and European banks would account for losses in the same way.
The rules are an attempt to answer complaints that the current accounting standards failed to give a proper insight into the risks banks held on their balance sheet in the run-up to a financial crisis.
However, critics argue that the changes will do little to improve transparency and will lead to a huge increase in disclosures as well as more volatility in banks results.
Nigel Sleigh-Johnson, head of financial reporting at the Institute of Chartered Accountants for England Wales, said there was “little evidence” that accounting rules played a “signifcant role” in the financial crisis.
“It is important to be realistic; this is not going to be a panacea. There are potential pitfalls linked to any model, including expected loss models; the proposals could, for example, increase the potential for profit smooting,” he said.
Giving evidence this week to the Commission on Banking Standards, Sir Mervyn repeated his assertion that Britain’s major lenders still do not have enough capital given the losses they still have to take on their existing assets.
The Financial Services Authority is due to release its report on bank capital levels later this month, is expected to identify large capital shortfalls at some lenders.
