Should banks follow more conservative loan loss rules?

Hockey93 writes:
Just read this article in the WSJ about an agreement between the FASB and IASB on changing loan-loss rules. The two boards have agreed in principle on a new standard for loan-loss accounting. The new standard will require banks to book loan-losses sooner. Banks will shift to the “expected loss” model from the “incurred loss” model which is currently used. Under the proposed standard, banks would book losses on loans immediately if the cash flows are expected to be recovered within 12 months. Also, additional losses will be recorded over the lifetime of the loan if a loan’s credit quality has deteriorated to a “more than insignificant” amount and there is enough of a possibility of default that the cash flows may not be recoverable.

I agree with this new proposal. It is a lot more conservative than the current standard and I feel is safer for the economy. Currently, banks book losses only after they have been incurred. This is part of the reason for the recent recession and its severity. If the new proposal had been implemented back then, there would have been a bigger alert that something is wrong. Maybe, the recession would not have been so severe if this standard was in place instead of the incurred loss standard. Banks would have been able to project that they were going to incur losses and have been able to to re-finance the loans or something else. I feel that this new standard will help prevent future problems and may curtail banks’ risk taking because of the acceleration of booking losses. I think this proposal is very good and should have no problem becoming a standard. What do you think?

Here’s the article, http://online.wsj.com/article/SB10001424052970203733304577102650251402654.html

Michael writes:

U.S. and international accounting rule makers have agreed in principle on a new standard for recording loan losses that may require banks to book some losses more quickly. The new rules would require banks to forecast losses on their books in a category known as “expected losses,” under which they would book losses and set aside loan-loss reserves based on future projections of losses. That would differ from the current system, known as an “incurred-loss” model, which requires evidence that a loss actually has occurred before the loss can be recorded.
I believe this is a very wise move as it will force banks to be more conservative in their financial outlooks. This will help investors, analysts, and regulators get a more accurate view of how the company is doing.

I write:


OKAY, you both agree that this would be good.  Then why didn’t the FASB and SEC do this a long time ago?

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About Mark P. Holtzman

Chair of Accounting Department at Seton Hall University. PhD from The University of Texas at Austin. Worked at Deloitte's New York Office. BSBA from Hofstra University.

One comment

  1. I believe that FASB and SEC did not implement this "expected-loss" model, under which they would book losses and set aside loan-loss reserves based on future projections of losses because it weighs heavily on honesty and integrity of the reporting parties/companies.From past experiences, these virtues are rare in the business world. Therefore,it is reasonable to assume that these projected or anticipated loses will be determined relative to companies' CFO/CEO ulterior motives and personal agendas, instead of investors' best interest.Also, there is a great potential for phony numbers being reported. In other words, I think this move will open the door for fraud, which is what the SEC and FASB should be trying to prevent.

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