18 April 2013

PwC IFRS blog: Impairment - What is the right answer?

Both the FASB and IASB have published their proposals on the recognition and measurement of expected credit losses for financial instruments. The good news is that they are available for comment; the bad news is that the proposals are not only different, but arguably both depart from the underlying economics in favour of operational shortcuts.

Digging deeper, the next question is whether there is any correlation between the current level of a bank’s reserves/capitalisation (banks are the most impacted by the proposals) and the economy it operates in, and its preference for a model. It seems that there is. While some banks expect that, under the IASB model, their impairment loss allowance will double, others argue that they would end up releasing loss allowances. Setting aside the conceptual question of how that might happen when moving from an incurred loss model to any iteration of an expected loss model, I have to admit that the impact of the proposal is highly dependent on current reserve levels and the economic situation...

Previously, preparers, users and regulators had considered that convergence was extremely important. The question is now whether respondents believe that the urgency of the need to move to an expected loss model outweighs the drawback of having two versions.

What will happen after the comment periods end? The boards have said that they will share their feedback and decide on the next steps. Although many institutions (including the Financial Stability Board and the Basel Committee) have expressed their disappointment on the lack of convergence, a converged model is unlikely. I don’t expect either board would move to accept the other’s proposal.

Potential compromises might include taking a period longer than 12 months, but shorter than lifetime, to measure expected credit losses on initial recognition. But, during previous discussions, the boards considered and rejected the 24-month alternative. Another possibility would be to try again with a conceptual solution (for example, consider the lifetime expected credit losses at inception but, rather than recognise immediately in the profit or loss account, spread the expense over the instrument’s life), but this would add a further significant delay.

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