(Repeat for additional subscribers)
July 25 (The following statement was released by the rating agency)
Impairment reserves for banks are likely to rise as a result of new accounting rules published yesterday that introduce an expected-loss approach for loan-loss provisioning, Fitch Ratings says. But additional provisions will not necessarily hit regulatory capital for all banks as technical differences will remain in the financial statements and regulatory reporting definitions of expected losses.
Banks using internal models under Basel's advanced approach calculate their own expected loss for regulatory capital calculation, rather than relying directly on accounting impairments. Therefore the effect of higher impairment charges as a result of the new accounting standard is likely to be moderated for these banks, depending on each bank's new level of provisions compared with the regulatory expected loss.
In contrast, banks under the Basel standardised approach do not calculate a regulatory expected loss and specific impairments flow directly into regulatory capital. Therefore, the impact of these accounting changes may be more significant for banks and portfolios under the standardised approach.
Regulatory and accounting 'expected loss' are quite different, although confusingly they share the same name. The regulatory calculation requires 12-month expected losses to be recognised and its scope is limited to portfolios under the internal models for regulatory capital. IFRS conversely, requires full lifetime losses to be recognised for some assets and applies to all loans at amortised cost. The regulatory approach also requires 'downturn' losses in the 'loss given default' calculation - a key input into the expected loss - whereas the accounting framework reflects current conditions.
The new accounting standard is intended to be more forward-looking, allowing management to factor forecast changes in conditions into the impairment charge. It will make provisioning more prudent (it will increase impairments) but at the cost of additional complexity. Implementation will involve considerable judgement and add to the degree of subjectivity already inherent in loan loss provisions.
We believe the increased disclosure proposed in the new IFRS standard is essential to improve transparency and will benefit users, particularly when combined with the take-up of recommendations around credit risk reporting by the Enhanced Disclosure Task Force. However, meaningful comparisons between provisions reported by US GAAP and IFRS banks will still be difficult, as the standards differ.
The International Accounting Standards Board issued the final IFRS 9 standard on financial instruments yesterday following a five-year consultation, but we still have some time to wait until we see the new reporting. It will need to be endorsed by policy makers before it can be used in the European Union. Assuming that happens without delay it will come into effect in 2018, and in any case will be effective in jurisdictions outside the EU at that date. In the meantime, the Basel III reforms have already introduced significant new regulatory buffers that should enable banks to better weather periods of higher loan losses that emerge.