The IFRS's latest attempt to simplify international accounting rules scores some small victories, but it also introduces a number of significant new problems into the accounting equation.

Will it be easier to understand what is happening in a bank under the new accounting rules – IFRS 9 Financial Instruments – published in July 2014, but due to come into effect in 2018?

Straight off, let’s congratulate the International Accounting Standards Board for removing one anomaly that has caused huge confusion – the past need to revalue a bank’s own liabilities and then recognise the change in the profit and loss account. This meant that when a bank’s credit rating deteriorated, the mark-to-market value of its bonds was reduced and this translated into a boost in profits.

This was always a huge challenge to explain to anyone who wasn’t an accountant: so the bank does badly, its bonds are trading at a discount but profits grow because on a mark-to-market basis it owes less. “You mean if I trash my credit card and my credit rating tanks I am worth more?” was a common riposte.

The point being that neither individuals nor banks pay back their debt at the mark-to-market valuation unless they go bankrupt. Until that point they pay it back at par which means that whatever it trades at has no impact on current liabilities.

This was a case where an attempt to be too scientific about accounting ended up creating a nonsense. Things should be more straightforward from now on.

But the bigger part of the IFRS package is the introduction of an expected-loss impairment model. Previously, credit losses could only be provided for after they had occurred – this meant that banks might still be paying out dividends even though it was clear that large loan losses were about to hit the balance sheet and higher provisions were needed. This was commonly the case during the financial crisis.

There are huge complications in the new approach – the US system will be different to the IFRS one; banks using internal models under Basel’s advanced approach will be impacted differently and less drastically than banks using the standardised approach; there will be a ratcheting-up effect as banks move from expected losses on a 12-month horizon to losses over the lifetime of the loan.

All the various provisions made will go straight through to the profit and loss account. On some estimates, provisions will increase by 50%, making quite an impact but, critically, the hit will depend on the judgement of bankers about the outlook for their loan book and the nature of their risk management system.

This means that whereas the changes to the treatment of liabilities makes the accounts easier to understand, the introduction of an expected-loss impairment model will make things a whole lot more confusing.

Arguably, keeping banks safe is more important than completely transparent accounts, but at some point there will be charges of banks hiding profits through overly pessimistic provisioning while shareholders may decide that banking is not an attractive industry. The weak point of the expected-loss impairment model is that banks will be even more difficult to understand. 

Brian Caplen is the editor of The Banker.

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