Download Impact of New Accounting Rules on Bank Regulatory Capital and more Study notes Accounting in PDF only on Docsity! 1/2 Accounting provisions and capital requirements – Executive Summary The International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) have both developed new provisioning standards for financial instruments based on expected credit losses (ECL), with effective dates of 1 January 2018 and 1 January 2020, respectively. The ECL accounting approaches under both methodologies have introduced fundamental changes to banks’ provisioning practices in qualitative and quantitative ways, and higher provisions are possible with the lifetime loss concept and the inclusion of forward-looking information in the assessment and measurement of ECL. Impact of accounting provisions on regulatory capital The new accounting methodologies directly impact the regulatory capital calculations under the Basel Capital Framework, since accounting provisions affect regulatory capital through the profit and loss statement. As the accounting changes are likely to affect bank regulatory capital, in March 2017 the Basel Committee on Banking Supervision (BCBS) issued interim guidance and announced transitional arrangements on the regulatory treatment of accounting provisions. Under the old “incurred” loss accounting methodology, provisions were only recognised once a loss event occurred. The new accounting ECL standards eliminate this threshold and require banks to provision based on ECL. The FASB rules require the recognition of the entire lifetime ECL at credit inception. Meanwhile, the International Financial Reporting Standards (IFRS) rules initially only require the recognition of the first 12 months of the lifetime ECL, with the full lifetime ECL required once an exposure has experienced a significant increase in credit risk. Impact of accounting provisions for banks under the standardised approach (SA) Under the SA, accounting provisions – for regulatory purposes – are classified into Specific Provisions (SP) and General Provisions (GP). GP are provisions held against future, unidentified losses. SP are provisions ascribed to the identified deterioration of particular assets or liabilities that are excluded from GP. GP may be included in Tier 2 capital up to 1.25% of the total credit risk-weighted assets (RWAs). SP may not be included in Tier 2 capital but are netted against the gross exposure amount before applying the risk weights. The impact on Common Equity Tier 1 (CET1) capital is dependent on two components: First, the size of the accounting provisions under ECL versus the incurred loss approach. This is expected to have the largest impact on SA banks, as the ECL approach is a new concept for them. Second, the classification of accounting provisions into SP or GP, based on the criteria defined by regulators in individual jurisdictions. Impact of accounting provisions for banks under the internal ratings-based (IRB) approaches Under the IRB framework, the differentiation between SP and GP is not made. Total eligible provisions are defined as the sum of provisions attributed to exposures treated under the IRB approach. IRB banks are required to calculate a regulatory measure of expected loss (EL). Where accounting provisions exceed the regulatory EL amount, the difference may be added back to Tier 2 capital, subject to a threshold of 0.6% of credit RWAs under the IRB framework. If regulatory EL exceeds accounting provisions, the shortfall is
