Accounting rules for bank loans are “backward-looking,” “unsatisfactory” and fail to reflect banks’ true losses, the Bank of Ireland governor said.
Patrick Honohan used a speech to the Chartered Accountants of Ireland on Tuesday to rail against rules on loan-loss provisions, which dictate how much banks should set aside for bad loans.
“I have already railed elsewhere against the backward-looking loan-loss provisioning practices encouraged by International Financial Reporting Standards and still all too pervasive in the reporting by most of the Irish banks,” he said.
“I find it unsatisfactory that expected losses in many parts of the portfolio are clearly higher than the provisions already taken, because I fear that this evident and in some cases explicit discrepancy may awaken doubts in the minds of investors as to the relevance of other aspects of the reported accounts.”
Under the current model banks only recognise a bad loan if there is a “trigger” – an observable event which casts doubt on whether a loan will be paid. The model was criticised in the wake of the crisis for allowing banks to recognise bad loans too late in their economic cycle. G20 leaders urged the International Accounting Standards Board (IASB) to examine the issue in April 2009 alongside a number of prudential regulators from around the world.
A forward-looking model, which forces banks to set aside money for future losses, is now being debated by the IASB and is scheduled for release in the first half of 2011. Banks have argued against the new model, believing it to be impractical and subjective.
Honohan’s comments add to a growing tide of criticism aimed at international accounting standards in recent months. Tim Bush, a member of the Urgent Issues Task Force set up by the Accounting Standards Board (ASB), believes international accounting standards overstated profits in the lead up to the banking crisis. He joined Bournemouth University professor Stella Fearnley who has said prudence, as an accounting principle, was discarded when the UK adopted international accounting rules in 2005.
Sir David Tweedie, chairman of the IASB has described the criticisms as “baloney” claiming earlier accounting rules would have more deeply buried banks’ true losses. Mervyn King, governor of the Bank of England, also recently told the House of Lords, accounting rules was not “an excuse for imprudent behaviour”.
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