Banks have to make provision earlier on bad loans under new global ruling

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Banks must provision for souring loans much earlier under an international rule published yesterday that will take effect in 2018, a decade after a global financial crisis the accounting reform seeks to stop recurring.

The collapse of Lehman Bros in 2008 highlighted how little capital banks held to cover a slump in the value of the assets on their books, forcing the public to bail out many lenders.

Amid a welter of regulatory reforms following the crisis, the group of 20 leading economies (G20) called for a single global accounting rule that would force lenders to make provisions for souring loans much sooner after a loan is made, so banks have time to plug any capital gaps.

The downside is that bank results will become more volatile, given that lenders have habitually delayed taking losses on bad loans partly to smooth their reported profits over time. A majority of banks surveyed by accountants Deloitte expect their provisioning to rise by up to half, under the rule, known as IFRS 9, published by the International Accounting Standards Board (IASB) yesterday.

The IASB, whose rules are applied in over 100 countries, including Europe but not in the United States, said it was its final reform in response to the 2007-09 crisis.

The rule will require banks to set aside some capital to cover loans on day one, and recognise full life-time losses on the loan if risks have increased, such as if a repayment is more than 30 days late.

In the run-up to the crisis, banks only made provisions when a loss had been incurred, typically at the point of default.

Accountants warn the change will lead to banks holding more capital, as well as causing bigger swings in their financial fig- ures.

“The focus on expected losses is likely to result in higher volatility in the amounts charged to profit or loss, especially for financial institutions,” accounting firm EY said.