26 February 2020

Veron: Banks in the Pandemic Turmoil: Capital Relief Is Welcome, Supervisory Forbearance Is Not

Economic disruptions due to the COVID-19 pandemic have compelled bankers on both sides of the Atlantic to call for relaxation of accounting standards that were introduced in the wake of the global financial crisis.

These standards, known as expected credit loss provisioning, were intended to limit procyclicality, namely the exacerbation of shifts in asset prices as a result of the application of accounting and/or regulatory requirements. Policymakers and accounting standard-setters should refrain from changing the applicable standards in haste and should ignore the bankers’ admonishments. There is no perfect accounting thermometer for credit risk in banks’ loan books, but breaking the current thermometer in the midst of a crisis would do more harm than good.

Expected Loss Versus Incurred Loss Provisioning

Because there are two main sets of accounting standards in the world, the debate on expected credit loss provisioning is actually two different debates echoing each other. In the United States, accounting standards are set by the US Financial Accounting Standards Board (FASB), a nonprofit body overseen by the Securities and Exchange Commission (SEC). The relevant FASB standard is Accounting Standards Update (ASU) 2016-13, Measurement of Credit Losses on Financial Instruments. ASU 2016-13 just entered into force for large listed banks, since it is to be applied on financial statements starting on or after December 15, 2019. Following a further update in November 2019 by the FASB, the corresponding date for smaller banks (all large US banks being publicly listed) is December 15, 2022.

In the rest of the world, most large banks use International Financial Reporting Standards (IFRS) set by the International Accounting Standards Board (IASB), a global standard-setting body hosted by the nonprofit IFRS Foundation. The relevant IFRS standard is IFRS 9 on Financial Instruments, issued by the IASB in November 2013 and endorsed three years later by the European Union, among other jurisdictions. IFRS 9 has been implemented for some time since it became effective for annual periods starting on or after January 1, 2018.

 

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