US Currency Comptroller John Dugan said accounting-standard setters are heading in the right direction, but he raised concerns about the proposal. ‘If expected loss is interpreted in a way that constrains it so you don't get to look forward, then we will not have made much progress,’ he said.
Proposals for a new loan-loss accounting standard, published on November 5 by the International Accounting Standards Board (IASB), are ‘potentially too restrictive’ according to John Dugan, US Comptroller of the Currency. Speaking to Risk on an article to appear in its December issue, Dugan applauded accounting standard-setters for moving in the right direction, but identified concerns with elements of the IASB's proposals, and with the direction signalled by its US counterpart, the Financial Accounting Standards Board (FASB).
Politicians and regulators have attacked current accounting rules – under which banks can only report losses and set aside money to cover them after a tightly-defined trigger event – for delaying recognition of losses and helping to magnify the scale of the crisis. The IASB's proposals address those criticisms by shifting to an expected loss approach, in which banks estimate how much money they will lose on a loan and use that to arrive at a credit-adjusted interest rate: as revenues rolled in, some proportion would gradually build up as a reserve.
The speed with which reserves build up depends to a large extent on how banks calculate expected loss. Dugan says the proposal, as it stands, might not do enough to tackle pro-cyclicality. ‘If expected loss is interpreted in a way that constrains it so you don't get to look forward much more than you do under the incurred loss model, then we will not have made much progress – and there are words used in the proposal that could be construed as overly constraining.’
Under the proposal, banks will have to calculate expected loss over the life of the loan, but the standard-setter also says the loss estimate has to be tied directly to each loan. Banks cannot make the estimate more conservative by building in an assumption of economic stress. In the language of credit modelling, there is a distinction between point-in-time and through-the-cycle measures.
‘This is exactly the issue people are asking questions about’, Dugan says. ‘what do you mean when you say expected loss? I think this is moving in the right direction. We just hope the details are as promising as the conceptual change appears to be’.
The head of the Office of the Comptroller of the Currency is also criticising elements of the FASB's plans. Although the standard-setter won't publish proposals for some months, it has announced its intention to make loss recognition and reserving more forward-looking.
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