Magazine article Independent Banker

Accounting Liabilities

Magazine article Independent Banker

Accounting Liabilities

Article excerpt

New accounting standards expected to pose another hurdle for lenders

Every community bank in the country will be required to revise how it accounts for loan-loss reserves and securities under proposed accounting reforms due to be finalized as soon as this year. The Financial Accounting Standards Board has proposed an accounting standards update that would compel banks to recognize credit losses much earlier in the credit cycle than currently required. The standards are expected to be released in the fourth quarter.

Independent Banker talked with ICBA accounting expert James Kendrick, the association's vice president of accounting and capital policy, about what community banks can expect.

IB: What is being proposed by FASB?

Kendrick: The FASB has proposed a single approach for recognizing credit losses on all types of loans and trade receivables. The plan would change the current incurred loss model, in which banks record a credit loss due to a triggering event or probable impairment, to an expected-loss model based on statistical projections and detailed forecasts.

Currently, community banks that follow Generally Accepted Accounting Principles normally don't record a provision for credit losses unless they have evidence that they'll incur a default. Under the FASB plan, banks would instead take a hit the moment they make a loan. Basically, banks would be required to estimate expected credit losses for the life of a financial instrument and recognize the net present value of those losses at origination.

IB: How would this affect community banks?

Kendrick: For one, it would require all banks to institute and maintain complex and expensive modeling systems; a Magic 8 Ball isn't going to cut it. Obviously this takes away a great deal of discretion from community banks to make localized financial decisions, which is of course a big part of what community banking is all about. But pushing up loan losses in the credit-loss cycle to the point of origination also effectively penalizes community banks for investing in their communities.

IB: And obviously that has an effect on consumers.

Kendrick: Absolutely. It's going to mean more capital tied up in the allowance, which means lower regulatory capital and fewer loans to consumers and yet another ding to local economic growth. The Office of the Comptroller of the Currency estimates that the proposal will increase loan-loss reserves by an average of 30 to 50 percent.

IB: What does this mean for regulatory scrutiny?

Kendrick: This is one of our biggest concerns. For all the complex systems banks will have to employ to project multiple outcomes and cash flows, I just don't know that banks will ever be able to get the equation right from the regulators' perspective. There's always another rock to look under, right? …

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