LEX Problem: lumpy bank writedowns. Quick solution: change the accounting rules. In the hope of avoiding a plethora of bank writedowns in any future downturn, theInternational Accounting Standards Board released draft rules on Thursday to change the way banks in about 100 countries report loan losses. The new “expected loss” system will allow provisions to be taken for loan losses over the life of a loan. Currently, provisions are made only when a loss is apparent.
How capital requirements will be affected is uncertain, but the change is a step in the right direction. In effect, large future writedowns will spread out and the provisions will paint investors a more accurate portrait of the risks in a bank’s loan book. But just as the new rules solve the problem of lumpy writedowns, they may also open a Pandora’s Box of ways to massage earnings.
Banks themselves will estimate the risks of their loans from inception to winding-up. One may choose to make provisions based on future interest rate rises. Another may write down assets based on unemployment estimates. This raises the prospect that loan-loss provisions might be used as cookie jar reserves to tinker with earnings. The larger and more diversified the loan portfolio, the more levers will exist to stage-manage results.
Wise to this risk, standard-setters will throw at investors a host of additional disclosure information on loan portfolios and impairment estimates. But the downside of forcing banks to churn out even more data is that meaning could be lost under a swathe of detail. Pity then the retail investor. Royal Bank of Scotland’s most recent annual report was 300 pages long. Few besides research analysts have the heart to go through it all. The IASB has substituted lumpy writedowns for lumpy reports.
