On expected credit loss accounting

On 7 December 2015, David Grünberger, Deputy Head of Division Integrated Financial Markets at the Austrian Financial Market Authority, gave a SAFE Policy Center Lecture entitled “Expected Credit Loss Accounting: A Key to Financial Stability?”. Grünberger presented simulation results for the introduction of the new IFRS 9 impairment rules based on expected loss accounting. The new impairment model, as he held, relates to more than only accounting, as it will affect the overall regulation of banks, bank capital and, by influencing bank behavior, lastly also financial stability.

Previous impairment rules based on incurred loss approaches have been blamed for having contributed to the scope of the financial crisis by delayed and insufficient recognition of credit losses. Early in 2009, the G20 therefore appealed to the International Accounting Standards Board to “strengthen accounting recognition of loan-loss provisions by incorporating a broader range of credit information” and to “improve accounting standards for provisioning”. As a result, IFRS 9 (International Financial Reporting Standard 9 for Financial Instruments) will replace the IAS 39 (International Accounting Standard 39) on January 1, 2018, with several far-reaching changes, geared to requiring earlier provision for expected credit losses.

Grünberger’s simulations lead to expected conclusions: with IFRS 9, higher provisions are made for expected credit loss and frontloading of provisions occurs, whereas incurred loss accounting is characterized by back-loading. Grünberger sees an unexpected result in the slightly higher volatility of income from bearing credit risk under the IFRS approach. Grünberger agreed with the critics of previous accounting approaches that impairment rules need to be more forward looking than before. Here, the quality of the projections will prove essential. He emphasized that communications with investors, to explain the higher provisions for long-term loan losses, will be key to maintain funding conditions.