InvestmentsJul 24 2014

Banks face big change in accounting for losses

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Lenders will take a more forward looking approach to recognising losses on their balance sheets at an earlier stage, following the culmination of a five-year project to make company accounts paint a more accurate picture.

The international accounting standard setter on Thursday published a standard on financial instruments, a key part of which is a change in the impairment model for how companies recognise losses, reports the FT’s Harriet Agnew.

The new standard, issued by the London-based International Accounting Standards Board as “IFRS 9 Financial Instruments”, moves from an incurred loss model to an expected loss model, marking a big change for banks, insurance companies and the users of financial statements.

For the first time, banks will have to recognise not only credit losses that have already occurred, but also losses that are expected in the future. This is designed to help ensure that they are appropriately capitalised for the loans that they have written.

Concerns about impairment came under the spotlight during the financial crisis because banks were unable to book accounting losses until they were incurred, even though they could see the losses coming.

At times the incurred loss rule meant banks overstated profits up front and didn’t make prudent provisions against expected losses, particularly in areas such as the loans they secured against real estate.

At the G20 summits in 2009, world leaders declared that improvements needed to be made to financial reporting and the IASB took up the baton to address the weakness in existing standards, alongside its US counterpart, the Financial Accounting Standards Board.

The new standard, which will come into effect on 1 January 2018, means that companies must make a provision for potential credit losses over the next 12 months. Where credit risks are deemed to have increased significantly, banks have to record the lifetime expected credit loss.