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Loan Loss Reserves11/12/09 - A proposal published recently by the International Accounting Standards Board (IASB) would cause banks to completely change the methodology that is currently used to account for loan losses.Currently, both IFRS and GAAP use an incurred loss model for the impairment of financial assets. This model assumes that all loans will be repaid until evidence to the contrary (known as a loss or trigger event) is identified. Only at this point is the impaired loan (or portfolio of loans) written-down to a lower value. The global financial crisis has led to the criticism of the incurred loss model for presenting an initial, over-optimistic assessment of no credit losses, only to be followed by a large adjustment once a "trigger event" occurs. Under the proposed changes, as outlined in a recently released IASB exposure draft, expected losses would be recognized throughout the life of the loan (or other financial asset measured at amortized cost), not just after the loss event has been identified. This would avoid the front-loading of interest revenue that occurs today before a loss event is identified, and would better reflect the lending decision. The IASB notes that under the proposal, a provision against credit losses would be built up over the life of the financial asset, which, under proposed disclosure requirements, would provide investors with an understanding of the loss estimates that an entity judges necessary. Experts claim that projecting expected cash flows can be more difficult than projecting expected losses, because it requires projecting interest rate curves for prepayments. |
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