Estimated credit losses are causing headaches for the banking sector as a result of the economic downturn resulting from the pandemic, but the London-based International Accounting Standards Board has published some guidance that attempts to clear the fog.
The IASB published guidance for banks and similar entities last week noting that estimated credit losses (ECL) need to be recognised when a bank determines there is a significant increase in credit risk (SICR).
While the standard setter makes it clear the ECL must be recognised if bank assesses that there is a SICR, the standard setter does not hold a financial statement preparer’s hand to tell them what approach to take or how banks should assess credit risk.
This means that the assessments of ECL requires professional judgement. It may result in a bank tweaking their approach to assessing losses if circumstances change and assumptions about the market or the ability of borrowers to pay the back what is owed need altering.
An example the IASB points to is the granting of payment holidays by banks in the current circumstances. The standard setter notes that “the extension of payment holidays to all borrowers in particular classes of financial instruments should not automatically result in all those instruments being considered to have suffered an SICR”.
An act that pauses payment of a class of loans, for example, does not automatically mean an increase in credit risk. The status may change if the individual or company cannot pay the loan in the long term, but the assessment must bear in mind the risk of a default occurring over what is described as the expected life of a financial instrument.
“Entities are required to develop estimates based on the best available information about past events, current conditions and forecasts of economic conditions,” the IASB observes.“In assessing forecast conditions, consideration should be given both to the effects of covid-19 and the significant government support measures being undertaken.”
The accounting standard setter acknowledges that the degree of difficulty for banks and similar institutions needing to try and factor in the impact of the pandemic in estimates.
“Changes in economic conditions should be reflected in macroeconomic scenarios applied by entities and in their weightings. If the effects of covid-19 cannot be reflected in models, post-model overlays or adjustments will need to be considered,” the IASB noted. “The environment is subject to rapid change and updated facts and circumstances should continue to be monitored as new information becomes available.”
The IASB noted that banks and other institutions would be able to use the standards reporting requirements including the disclosures to provide readers of financial statements with a transparent account.