Investors and regulators are hoping to see the Financial Accounting Standards Board and the International Accounting Standards Board somehow reconcile their differing approaches to accounting for loan impairments and credit losses in their financial instruments project.
At a meeting of the Basel Committee on Banking Supervision in April, banking regulators from around the globe urged the standard-setters to at least provide enough disclosures to enable investors to understand the differences under International Financial Reporting Standards and U.S. GAAP. After working for more than a decade to converge the financial instruments accounting standards, FASB and the IASB were unable to reach agreement in a number of areas, including credit losses and loan impairments.
However, regulators and investor groups would like to see the two boards at least provide guidance or disclosures that could allow them to better compare the different numbers, as FASB and the IASB did several years ago when they were unable to reach a converged solution for offsetting financial assets and liabilities on the balance sheet, also known as netting (see FASB, IASB Make Progress on Netting, Leasing and Impairment Standards). The IASB released its financial instruments standard last year, known as IFRS 9, and FASB is expected to release its version this year.
“We’ve had some guidance which was put forward by the Basel Committee on Banking Supervision, to try to encourage consistent implementation,” said Vincent Papa, director of financial reporting policy at CFA Institute, a group that represents Chartered Financial Analysts, during an interview with Accounting Today last week. “This is the focus on IFRS 9, but they’ve also been looking at the FASB model because they’re both expected loss models, and the question will be how well and how comparably and consistently will entities be trying to implement this? The Basel Committee was trying to get all the stakeholders together, so they had securities regulators, auditors, banks, standard-setters and a few investors at the table as well, to try and really get their thoughts around what’s required to assure consistent implementation and the question of the kind of disclosures that investors would like to have, both in transitional periods in the run-up to the standard as well as when the standard is finally adopted.”
The April meeting of the Basel Committee included a roundtable discussion bringing together representatives from FASB, the IASB, the Securities and Exchange Commission and other parties. Among the participants were IASB chairman Hans Hoogervorst and SEC chief accountant Jim Schnurr, who recently suggested that FASB and the IASB set up a joint transition resource group to provide guidance on the credit loss standard similar to what they have for implementing the revenue recognition standard (see SEC Chief Accountant Backs Away from IFRS Proposal). Disclosures on expected credit losses might dovetail with the work of the Financial Stability Board’s Enhanced Disclosure Task Force.
“Its mandate was to come up with a disclosure regime or disclosure recommendations for the banks to voluntarily adopt on risk reporting,” said Papa. “There are 32 recommendations that were put forward, and these have been encouraged across various jurisdictions. They have been well adopted in the U.K. and Canada, but less so elsewhere. These are very influential and are often cited by many stakeholders. Its work has been getting lots of traction. In the context of the ECL model, this group is also going to be looking at what disclosures investors would require because it’s very much a collaboration of various industry leaders. They’ve got institutional investors, auditors and banks all talking to each other. It sometimes helps to have a meeting of minds, so that will be important.”
The expected credit loss model from the accounting standard-setters will also need to tie in with the regulatory expected loss model from banking regulators, as European and U.S. banks have different allowances for loan losses depending on how conservative they are. Another issue surrounds the auditability of the expected credit loss model. The International Auditing and Assurance Standards Board may need to update one of its International Standards on Auditing.
“What needs to be amended is not really clear because there’s the view that auditors have always developed estimates, so expected loss is just another estimate,” said Papa. “However, when you look at regulatory findings, clearly there are issues around the audit of allowances for loan losses. So the question is are they really up to the mark, especially when you incorporate forward-looking inputs? How well equipped are they to provide assurance around those numbers?”
Banks might then need to set aside larger capital reserves if the loan losses are bigger than they expected.
“The magnitude is likely to be higher, but there is also a question of inherent multiple inputs, increasing multiple inputs that would be there within the model itself, and the forward-looking nature of the inputs,” said Papa. “The question arises as to how well geared are auditors to deal with this level of inputs.”
It is not clear that FASB and the IASB will be able to bridge those gaps as they did by recommending disclosures to compensate for differences in their netting and offsetting standards.
“What’s been acknowledged is that the disclosures cannot be seen as a reconciliation,” said Papa. “It will help you understand both respective numbers, but the disclosures never really get to the level that you can deem them to be a substitute for a reconciliation. They can help you move from one model to another. What companies always say is to give you such disclosures, it effectively means running both models, and they tend to argue that’s cost prohibitive for them. But ideally that’s what we would have liked, to see disclosures that help you get both. If they recognize one, give me disclosures about the other. That would certainly help.”
Financial analysts might be hard pressed to come up with their own assumptions about what the expected credit loss numbers would be under IFRS or U.S. GAAP if they only had one set of numbers and some additional disclosures.
“What they have proposed is disclosure around the inputs that determine the actual measurement levels, reconciliations,” said Papa. “From our point of view, they could even go further. For example, we were proposing that there is disclosure around the development of credit losses. That’s not required, but that would certainly help—the history and development of credit losses so that you have a sense as to what was actually projected vis a vis what was realized. You’ve got a sense of the estimation accuracy that’s in place and also how that tallies up with the prevailing economic environment.”
Will disclosures be adequate to bridge the gap? That isn’t yet clear. The Financial Stability Board’s Enhanced Disclosure Task Force is working on identifying further disclosures that can augment whatever has been proposed by the IASB, according to Papa.
“In addition to investors many other key market discipline-involved folks, like the bank regulators, the central bankers have supported the need to strengthen various aspects of the disclosures," he said. "One disclosure that is being considered is a reconciliation between the regulatory expected loss to the one that’s been proposed under IFRS 9. That would certainly help because the regulators are also calculating an expected loss version. And if you are able to then see how that tallies up with what’s been provided within the accounting framework, you understand where there would be differences if it’s assumptions around the probability of default or the loss given default, and the prudential regulators take a more conservative view. Then you understand that’s why you have a larger or smaller allowance. That would certainly help investors.”