FASB Wants Banks to Forecast Loan Losses

Banks could see their losses increase by about 50% under the proposed rules.
Kathy HoffelderFebruary 7, 2013

The latest exposure draft on accounting for credit losses from the Financial Accounting Standards Board could bring sweeping changes to the way that banks, financial institutions, and other public and private organizations account for credit losses on their balance sheets.

The exposure draft, released in December, would require entities to record extra losses from bonds or loans on their balance sheets sooner than they currently do. The proposal would also require them to forecast the future cash flows they do not expect to collect because of deterioration in the value of financial instruments over their lifetime. Currently, existing impairment models under generally accepted accounting principles do not require firms to recognize losses until they are incurred.

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In short, a firm’s balance sheet would now show the current estimate of expected credit losses at the firm’s reporting date, and its income statement would show how much a financial instrument may have deteriorated during the most recent quarter or year.

“The global financial crisis highlighted the need for improvements in the accounting for credit losses on loans and other debt instruments held as investments,” said FASB chairman Leslie Seidman in a statement announcing the proposal. “FASB’s proposed model would require more-timely recognition of expected credit losses and more-transparent information about the reasons for any changes in those estimates.”

The board has not yet field-tested the proposal, but on a press call in December, Seidman estimated that banks and other financial institutions would see their losses increase by about 50% under the new rule, even if they adopt only part of the proposal.

Just because an investment is currently doing well doesn’t mean that will be the case for the duration of the bond or loan, noted Seidman in explaining FASB’s reasoning. “You can’t avoid a loss just because an asset is currently performing,” she added.

In addition to the extra reporting steps, the new proposal would require considerable operational-system challenges, according to an Ernst & Young survey of financial executives conducted in February. Organizations would now be expected to forecast expected losses for the duration of the life of a bond or loan.

FASB has put its proposal out for comment until April 30, 2013. It will review comments during the summer and then “redeliberate” on the exposure draft, said Seidman. The International Accounting Standards Board, for its part, is due to release its own proposal on the topic for public comment in the first quarter of 2013.

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