The pan-global Basel Committee is likely to seek a tweak to capital rules to ease the comparison of bad-loan provisions by banks at a global level in the wake of disparities between new accounting standards being adopted in the U.S. and elsewhere in the world, S&P Global Ratings analysts said Feb. 19.
New rules under the International Financial Reporting Standard, known as IFRS 9, which was adopted by banks across Europe among others from Jan. 1, and similar U.S. rules known as CECL, due to be adopted in 2020, both have the same goal — to make banks hold capital against expected, rather than already-incurred, losses. Yet the International Accounting Standards Board, which manages IFRS, and the Financial Accounting Standards Board in the U.S., which manages that country's GAAP regime, have taken different approaches to estimating credit loss provisions.
The key difference is that under IFRS 9, loans are split into three stages, reflecting changes in credit quality over time. The CECL, or current expected credit loss, model to be used in the U.S. follows a single credit-loss measurement approach and requires banks to recognize lifetime expected credit losses for all assets, regardless of their level of credit risk.
S&P also noted that the multi-stage model used in IFRS 9 will require a "greater level of judgment by bank management teams about future outcomes," as well as about when to move loans into the "stage 2" category that requires a provision equal to the expected loss over the lifetime of the loan.
The difference will increase complexity and lessen comparability from bank to bank owing to potential wide variations in provisioning, which will be a big disadvantage to investors, S&P analysts said. This provides the Basel Committee with "a further impetus to formulate capital rules that, at the very least, maintain the current level of consistency and comparability in expected loss calculations for regulatory capital ratios," they added.
They said the committee is also unlikely to want to allow accounting rules to be the only determining factor in how banks provision for bad loans, given that provisioning "is a fundamental element of banking soundness."
S&P projected that IFRS 9-related provisioning will have only a limited effect on the key measure of capitalization, the common equity Tier 1 ratio, because the Basel Committee has already allowed the phase-in of those provisions into CET1 ratios over a period of three to five years, S&P said.
Accounting firm Deloitte has also warned of potential comparability issues between IFRS 9 and CECL. "The new U.S. rules are similar but different enough to make comparisons challenging. The disadvantage lies less with banks, more with investors to the extent they are trying to compare banks across different geographies," John Kent, co-lead of Deloitte's banking IFRS advisory practice, told S&P Global Market Intelligence.
Furthermore, some banks may need to adopt both standards.
"Those IFRS banks with U.S. operations may have to implement both rules if their U.S. operations apply U.S. GAAP. Conversely, U.S. banks with European operations may need to apply both if their European operations apply IFRS," Kent said.
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