Friday, June 10, 2011

FASB, IASB Struggle Over Forcing Banks to Own Up to Potential Loan Losses

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The Financial Accounting Standards Board and the International Accounting Standards Board are keenly aware that the bad loans banks hold on their balance sheets harbor the potential for another world financial meltdown, but they aren’t quite sure what to do about it.

The uncertainty emerged May 18 at their joint meeting in London when they were discussing how to create a joint standard for disclosing the impairment of financial assets. The boards are split over the proposal favored by FASB, in which loans are assigned to either a "good book" or a "bad book," and the one favored by IASB, which is a "floor" approach under which reserves would be required to be booked for expected losses on loans for the foreseeable future, but in any case for not less than 12 months.

But both boards agree that the stakes are high, as their May 18 discussion showed. "We have a potential sovereign debt crisis gathering pace and we really have to get this in place before anything happens in this area," outgoing IASB Chairman David Tweedie said. "The Basel committee will tell you that pre-crisis the banks did not hold back any profits, they gave them out in dividends, buy backs and compensation, and that's one of the things that horrified the regulatory world, the fact that there was that happening."

The current "incurred loss model" is not up to the task of disclosing potential devastating losses on bank holdings of sovereign debt of the strained economies of Ireland, Greece and Portugal, along with other stresses in the financial system, Tweedie said.

"If you look at the current situation, the incurred loss model leaves quite a bit of room for judgment," Tweedie said. "And still in Europe, there are many banks that have government bonds on their books which are trading at 50 percent in the market and they consider them not impaired. So I don't think that mere tweaking of the incurred loss model will help. They have to be forced to recognize possible losses at an early stage."

FASB Chairman Leslie Seidman said that a "tweaking" of current standards probably won’t cut  it; something more like "wrenching it" will be needed.

But while they have not gotten any closer to an agreement on exactly what is needed to sufficiently disclose and reserve against bad loans, they have pledged to try and reach agreement by the end of June.

For more information, check out the latest edition of BNA’s Accounting Policy & Practice Report . Not a subscriber? Sign up for a free 15-day trial  to Accounting Policy & Practice Report.

-- Steven Marcy, Accounting Policy & Practice Report

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