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Hoogervorst Says It’s “Decision Time” on Impairment Proposals

October 17, 2013

The FASB and IASB can’t agree on the best way to make banks and other financial businesses recognize losses on failing loans and assets. The boards plan to keep developing their individual proposals and trying to find common ground despite the growing likelihood that they will write separate standards.

IASB Chairman Hans Hoogervorst is offering little hope of the international accounting board agreeing with the FASB on the financial asset impairment proposals.

Speaking October 14, 2013, at a meeting of the IFRS Advisory Council in London, Hoogervorst said he and FASB Chairman Russell Golden met last week and agreed to further develop their respective proposals and then “compare notes.” The two boards plan to talk to each other “continuously” to see if they can come closer together on the high-profile project.

“Let’s not beat around the bush, we are in different places at this moment,” Hoogervorst said.

The boards are under pressure from international regulators, banks, and investors to overhaul existing IFRS and U.S. GAAP for loan losses.

The boards want banks and other financial businesses to estimate future loan losses and not stick with existing practice, which allows loss recognition only when those losses are “probable.” This means the customer may have stopped paying his loan, and losses have happened. In the aftermath of the 2008 financial crisis, the standard-setters wanted to give the markets better insight—and fewer surprises—about deteriorating assets earlier in the credit cycle.

But the FASB and IASB can’t agree on the same approach.

The FASB in December released Proposed Accounting Standards Update (ASU) No. 2012-260, Financial Instruments—Credit Losses (Subtopic 825-15), and the IASB in March issued Exposure Draft (ED) No. 2013-3, Financial Instruments: Expected Credit Losses.

The sticking point is that the boards differ on whether to differentiate between healthy assets versus those that have already deteriorated.

The FASB doesn’t want to draw a distinction and is determined to stick with what it calls a single measurement model. The U.S. board wants banks and other financial businesses to assess all reasonable, future losses on all types of assets.

The IASB wants banks to assess losses only for the next 12 months on performing loans and assets and “lifetime” losses for everything else.

At this stage, the odds are slim that the FASB will agree to the IASB’s plan, Hoogervorst said.

He added that the IASB has heard positive responses to its plan.

“We now have finally a model that is both operational and have heard lot of support from our constituents, so we feel very well placed to get this done in a short period of time,” Hoogervorst said.

Moreover, the IASB doesn’t want to follow the FASB’s lead because the U.S. board’s proposal would require the counter-intuitive booking of losses for newly originated loans that have no signs of decline. Critics of the FASB’s proposal believe it is overly cautious and could dry up bank capital by requiring banks to put too much money in reserves.

The FASB’s research staff estimates that loan loss reserves under the FASB model would increase 20% to 45%, while under the IASB model, reserves would be reduced 15% to 40%.

IFRS Advisory Council Chairman Paul Cherry said the FASB is in a tough place because if it bends to the IASB in the name of convergence, it will face criticism that it lowered bank reserves.

“They are going to face a media blitz that essentially says the standard-setters caved in, made changes held out to accelerate the recognition of losses, and lo and behold, they are doing the opposite,” Cherry said. “The differences are not dramatic, but they are lower. And even if they’re neutral, industry would say, ‘Why would you put us through this ordeal if you more or less accomplish the same thing?'”

Cherry, who was present at the FASB’s Financial Accounting Standards Advisory Council meeting in Norwalk, CT, October 8, when FASB member Thomas Linsmeier said the IASB “ain’t interested” in writing standards jointly with the U.S. board, asked Hoogervorst if the IASB had “thrown in the towel on convergence.”

“We have certainly not thrown in the towel, and we are determined to get this done,” Hoogervorst said.

Hoogervorst also tried to ease concerns that the IASB’s model was not much different from the much-criticized incurred loss model U.S. GAAP and IFRS have used since the 1990s.

“I am pretty confident that the model, as adjusted by the IASB, will lead to quite a significant increase in the level of provisioning in our financial institutions, and that concern from Americans—which I can understand before our further elaborations of our model—I think those concerns are no longer justified,” he said.

One IFRS Advisory Council member told Hoogervorst that if the FASB and IASB can’t agree on one impairment model, it would be a “disaster” for banks and investors.

Hoogervorst said he agreed and that the inability to compare financial statements between U.S. and international banks would be a bad outcome. But he didn’t offer a solution.

“We also have to think about the credibility of standard-setting,” Hoogervorst said. “We have had five years, six models. It’s decision time.”