Expected-loss model “well on the way”, says IASB

THE IASB AND FASB are making progress towards the introduction of an expected-loss model for banking assets, the chairman of the international standards setter said.

Speaking at the 3rd European Central Bank Conference on Accounting, Financial Reporting and Corporate Governance for Central Banks, IASB chairman Hans Hoogervorst said that both the IASB and FASB “are convinced that we need a more forward-looking impairment model”.

“In fact, we are well on our way to completing an expected-loss model,” he said.

Criticisms that IFRS’ current impairment model based on incurred, rather than expected, losses was “too little, too late” were “partially” justified, Hoogervorst said.

“The fact that the market capitalisation of many banks is far below their book value is an indication that market participants do not believe that their current level of provisions reflect economic reality,” he said.

However, Hoogervorst said he is convinced the incurred-loss model could have been applied more “vigorously” since the financial crisis.

“I do not think that there is a lack of triggers to start writing off certain assets. There has been simply too much hesitancy to do so or political pressure not to do so,” he said.

The model will require an allowance balance that captures the expected losses for all new financial assets in the next 12 months. If credit quality deteriorates so that contractual cash flows may not be recoverable, lifetime losses need to be recognised.

Hoogervorst added that to some degree, the expected loss model will rely on judgment, because it is not possible to predict with precision when the probability of default starts to accelerate.

In a warning to regulators, Hoogervorst said that new accounting rules would not be a panacea to the ills of volatile economic cycles.

“We have to keep our expectations realistic about the anti-cyclical effects of accounting rules,” he said. “Accounting standards are not an instrument of economic policy; they merely serve to depict financial and economic reality as reliably as possible. Dampening the economic cycle is neither our task nor within our area of expertise.

“The incurred-loss model provides too much leeway for procrastination and has to go. But an expected-loss model in itself should not be expected to significantly dent the pro-cyclicality of the credit cycle.”

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Fiona Westwood of Smith and Williamson.