IN April 2009, the G20 leaders met in London, catapulting accounting standards to the top of the political agenda. They called on the accounting standard setters to “take action…to reduce the complexity of accounting standards for financial instruments” and to “strengthen accounting recognition of loan-loss provisions by incorporating a broader range of credit information”. Fast forward over five years, and the long-awaited new financial instruments standard – IFRS 9 – has finally been published by the International Accounting Standards Board (IASB), bringing together the classification and measurement, impairment and general hedge accounting phases of its project to replace the much-maligned IAS 39. The IASB has finally crossed the finishing line. Regrettably, the international standard setter did not cross that line together with its US counterpart, the Financial Accounting Standards Board (FASB). Despite the two boards having worked very hard for several years to agree on a converged financial instruments standard, the standard setters have in the end gone their separate ways in some key respects. Perhaps most significantly, the boards have been unable to agree on a common approach to some key features of the new accounting model for the impairment of financial assets. This is critical, as it affects how and when banks recognize losses relating to their loan and mortgage books. In response to the G20's rallying cry, both boards are, importantly, moving from an ‘incurred loss' approach to a more forward-looking ‘expected loss' model. But there are considerable differences between the two models, especially with regards to the timing of recognition of such losses. The IASB is introducing a three-stage approach, which will see lifetime expected credit losses recognized only where credit risk has increased significantly since initial recognition. For loans that are still performing well, the only provision required is for credit losses that would arise from possible defaults within 12 months of the end of the reporting period. On the other hand, the FASB's standard, due out later this year, recognizes lifetime expected credit losses upfront for all loans. ICAEW does not support this model as it may lead to banks recognizing accounting losses when they advance new loans which are expected to be profitable, which could have unintended commercial and broader economic consequences. We doubt that recognizing ‘too much, too soon' is better than recognizing ‘too little, too late'. The difference in approach between the two standard setters is not ideal either from an investor or reporting entity point of view. Investors may struggle to compare banks' results across country borders and banks may have to get to grips with and use both new standards. Nevertheless, having a high-quality IFRS standard is more important than continuing the search for a fully converged solution with the US. And the IASB's new approach to loan-loss provisioning is overall a major improvement on the standard it replaces. One of the main benefits is that there is a greater focus on the level of credit losses expected in the future, allowing for earlier recognition of losses than is possible with the current standard. This should provide more timely information about the expected credit losses of banks and other financial institutions. The new standard is also more workable in practice and more principles-based than the current standard. There are inevitably potential downsides to any approach to loan-loss provisioning. The IASB's approach will, firstly, require the application by banks of more judgment than the previous model, which may make it harder for investors to assess a bank's financial condition. Secondly, the three stages approach for determining loan-loss provisions introduces a significant amount of complexity. Thirdly, considerable costs will be involved in meeting the new requirements, not only for banks and other financial institutions but also for other companies holding financial assets such as loans and bonds. Banks' provisions are likely to increase as a result of using the new standard, effective from 2018. And this, in turn, will have an impact on banks' regulatory capital levels. This does not necessarily mean that banks got their provisioning levels wrong in the past, and the new expected loss model should not be seen as a panacea by those who think that provisions made in the run-up to the global financial crisis were ‘too little, too late'; it won't result in provisions being made for unexpected losses. It will take some years – and perhaps the advent of a new financial crisis – before we can fully understand the impact of the new standard. Regulators and others will undoubtedly be watching carefully. But the completion of the project has been widely welcomed and few would disagree that this is a major and long overdue improvement to financial reporting. • The writer is Head of ICAEW's Financial Reporting Faculty
