If only Ritchie told us this

The FT has two articles this morning highlighting the failure of accounting rules to handle the impact of the coronavirus crisis, most especially in banking.

The problem that is being faced has persisted since 2005 when International Financial Reporting Standards were introduced as the de facto accounting standard system for the UK, the EU and over 100 other countries.

This is not the moment to critique the multitudinous failings of IFRS accounting, although they exist. It is instead the moment to note that they are the very opposite of the reasonably objective standards for reporting that any user of accounts might require, most especially at times like this.

The current problem relates to loss reporting.

OK, blah, blah. Effectively, current rules say you only recognise a loss on a loan when that loss has occurred. As opposed to what should, possibly, be done which is to recognise a loss when you think that a loss is going to occur.

For example, today, if you held the debt of a fracking firm you might reasonably think that it’s not going to pay you back all that cash. But it has done so far. Yes, probably better to be recognising that future loss right now. Perhaps with some probability weighting, net present value etc or summat.

So, Ritchie does actually have a point.

But there’s some fun to be had all the same:

The Financial Accounting Standards Board (FASB) issued the final current expected credit loss (CECL) standard on June 16, 2016. After the financial crisis in 2007-2008, the FASB decided to revisit how banks estimate losses in the allowance for loan and lease losses (ALLL) calculation. Currently, the impairment model is based on incurred losses, and investments are recognized as impaired when there is no longer an assumption that future cash flows will be collected in full under the originally contracted terms. This model will be replaced by the new CECL model.

Under the new current expected credit loss model, financial institutions will be required to use historical information, current conditions and reasonable forecasts to estimate the expected loss over the life of the loan. The transition to the CECL model will bring with it significantly greater data requirements and changes to methodologies to accurately account for expected losses under the new parameters.

The American system already works this way. Cool, so Ritchie is saying that we should adopt American accounting standards as they’ve already solved this problem. Except, of course Ritchie says no such thing. Either because he can’t bring himself to applaud the US method or because he doesn’t know about it.

Let’s now scrap this neoliberal form of accounting

Tchah, silly me, we can’t copy the Americans because they’re neoliberals, aren’t they?

10 thoughts on “If only Ritchie told us this”

  1. Except that it isn’t true.
    Gordon Brown decreed that tax should be charged on banks using calculations of what the profit would appear to be if you ignored unrealised losses on the loan portfolio BUT the IFRS requires banks to account for loans (except for certain financial instruments to be valued on an amortised cost basis) at “Fair Value” which means net of provisions for expected future losses.
    Murphy seems to be demonstrating his ignorance of IFRS

  2. Quelle surprise. He doesn’t understand IFRS 9. IFRS 9 actually deals with most of the things he’s complaining about. The old style of accounting – big bath provisions and the like – was a total fucking disaster. Banks used discretionary provisions to manage earnings. And they still failed.

  3. Dennis, Tiresome Denizen of Central Ohio

    The American system already works this way. Cool, so Ritchie is saying that we should adopt American accounting standards as they’ve already solved this problem.

    And introduced a whole new series of problems… Such as CECL relying heavily on economic forecasting. How many economic forecasts used by banks prior to January, 2020 took into account the possibility of a worldwide pandemic? Now all those wonderful pre-pandemic CECL calculations are shit, despite the use of best effort “reasonable” forecasting.

    Gonna rely on those pre-pandemic loan loss estimates and reserve numbers that banks gave us?

    The problem with using “reasonable” economic forecasts is this: There aren’t any. Economic forecasting on a global or national scale – over any relatively long period of time (like the length of a business loan) – is a joke, and always has been. CECL isn’t a panacea, it’s simply a difference approach with different strengths and weaknesses.

  4. @ Dennis
    For once “It’s different this time” is actually true.
    But the global pandemic is less of a problem for the USA than the UK as foreign trade is still smaller as a % of GDP. What you need to worry about is the domino effect of a succession of businesses going bust, probably starting with the least good restaurants, bars and hairdressers.

  5. Dennis, On The Front Lines Fightin' Them Chlorinated Chickens

    What you need to worry about is the domino effect of a succession of businesses going bust, probably starting with the least good restaurants, bars and hairdressers.

    True. And how do banks account for that under CECL? By pulling numbers out of their ass… Because nobody knows what the impact is going to be.

    What Spud doesn’t seem to grasp is no accounting standard can ensure accuracy when important relevant information is lacking and material uncertainty exists.

  6. Oh, Tim, IFRS 9 requires loan provisions to be made on an expected loss basis. So you’re wrong to agree with Ritchie, because he’s wrong to criticise IFRS for not having something it already has.

  7. Exceptional circumstances may not always be covered in a specific standard, who would have expected a self-imposed lockdown like this.
    This is why we have general standards and principles to fall back on, also part of the issue with US GAAP vs IFRS where US is more rule based so maybe more difficult to respond to these situations (as new rules are needed).
    Wouldn’t surprise me to seeing guidance being issued in these circumstances anyway.
    It’s better than the old days of having a list of ‘provisions’ that can be ‘reviewed’ to support quarterly targets

  8. Didn’t Murphy complain that bad debt provisions shouldn’t be allowed because they allowed banks to reduce their taxable profits?

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