Lease accounting proposals may restrict bank lending

There may have been few surprises in this week’s new lease accounting proposal by the International Accounting Standards Board (IASB), but that didn’t stop alarm bells ringing in the finance departments of some of the nation’s largest companies.

And while the affect for major supermarkets and airlines attracted most attention, it may be its impact on the troubled banking sector that threatens to reap the most damage on the UK’s fragile economy.

The leasing industry is big business. US estimates put the value of global leased assets at £765.8bn, which equates to about 21 times the UK’s annual defence budget. The current operating lease commitments of the top 50 FTSE 100 companies alone comes to about £94bn, according to a high level study by one major accounting firm.

But it’s in the troubled financial sector where the proposals may cut deepest. Banks are major lessees, holding thousands of properties in shopping malls and high streets where they operate retail outlets. Many of these leases are currently hidden off balance sheet, according to the IASB, which wants to bring them back on in the form of a “right-of-use” asset and a liability to pay rentals.

Banks are also significant lessors and under the proposals if a bank still holds the risks associated with a leased asset, it must report an associated liability.

Increased liabilities are bad new for banks which are bound by capital requirements set by regulators. If a bank’s balance sheet lists towards the liability side its ability to lend shrinks.

One analysis, by a Big Four auditor, found the UK's big five listed banks – HSBC, Lloyds Banking Group, Barclays, RBS and Standard Chartered – have total commitments of approximately £18bn.

HSBC Group Finance Director, Douglas Flint raised concerns in July 2009. In a letter to the IASB he warned that a new leasing model, “could have significant capital impacts for regulated entities such as banking institutions”.

The Finance and Leasing Association (FLA) said there has been little co-ordination with regulators, who set capital requirements, on the issue.

“Our members who are within the banks are worried about this,” said Julian Rose, head of asset finance at the FLA .

“If this standard results in them having to report higher liabilities their ability to lend would go down.”

Banks are under pressure to increase lending with business secretary Vince Cable last month unveiling a consultation with the Treasury aimed at improving cash flow to businesses.

John Williamson, audit and assurance partner with PwC, who has a number of banking clients, said banks had begun fretting about the IASB’s proposals.

“I know there is a concern there as far as the impact on regulatory capital… at the moment [regulators] are not following the strict accounting and it is probably a bit premature to assume it may have an affect on regulatory capital.”

Veronica Poole, senior partner with Deloitte, said the regulators may have to end up tweaking their capital requirements to reflect the new-look balance sheet.

“With any of this stuff, what you don’t know is whether the regulator will make an adjustment… The economics of the transactions have not changed,” she said.

The issue feeds into a wider debate about accounting standard setting. The lessor accounting proposals, which causes the liability-stacking issue, only wormed its way into the final standard as a concession to the US accounting rule maker, the Financial Accounting Standards Board (FASB).

The IASB and FASB have been attempting to converge their two accounting codes, but disagreed on whether to include changes to complex lessor accounting at all. At one point the two board had tentatively agreed to abandon the more complex lessor accounting treatment, but reconsidered them after FASB voiced concerns.

The disagreement has caused stirred opposition to the IASB-FASB relationship, which has been blamed for increasing complexity in financial reporting.

Brian O'Donovan, IFRS partner with KPMG, said there are now questions being raised about whether the relationship is adding complexity to accounting rules.

“The question is whether having those differences aired and thrashed out is a good thing…or whether you believe it just causes unnecessary complexity,” he said.

Plans have been in the pipeline for a new leasing standard since 1996. The proposals predate the formation of the IASB by five years, when the quasi-official G4 + 1 group of accountants decided the treatment of leases at the time was both arbitrary and unsatisfactory.

The leasing industry has lead the charge against the proposals last Tuesday with industry group Leaseurope warning the new accounting rule was so complex it had the potential to “overshadow the economic benefits” provided by European industry.

Among Leaseurope’s members are recognisable retailers, banks, transport companies and other major users of leases which have been privately modeling the effects of the proposals. Their tests suggest the standard could wipe 20-25% off their reported pre-tax profit.

Further reading:

New lease standard could destabilise corporate balance sheets

IASB and US FASB publish proposals to improve the financial reporting of leases