New accounting rules to force banks to book anticipated losses on loans

Tim Wallace
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BANKS will soon have to hold more capital in anticipation of losses on bad loans under new accounting rules to be published in the New Year, after sustained pressure from the G20 leaders.

The International Accounting Standards Board (IASB) is expected to publish its new guidelines in the first quarter of 2013.

Currently banks use an incurred loss model, allowing them to book the maximum possible profit on loans, artificially raising profits.

When some of those loans are not repaid, then bank then has to book the losses, hitting its figures.

As a result, banks had an incentive to manipulate the figures, building up reserves in the good years and paying them out in bad years, making it harder for outsiders to analyse the state of the bank’s books. Under the incoming plans – known as expected loss provisioning – the bank must look to its historical loan performance to judge the proportion of its loans that will default. The aim is to create a more transparent system which reflects the true state of the bank.

Meanwhile the unexpected losses, for example from another financial crisis, will fall outside the remit of the IASB, and instead be dealt with by the prudential regulation authorities. However, the move may also mean banks have to raise tens of billions in extra capital, because they have to book expected losses in advance of those losses occurring.