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A briefing on the IFRS proposal for an Expected Loss Model
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LOAN LOSS PROVISIONING
Brian S. McDaniel
ALLOWANCE FOR LOAN LOSSD
efinit
ionReserve for Bad Debts
Valuation reserve established and maintained by charges against a bank’s operating incomeEstimate of uncollectible amounts used to reduce the book value of loans and leases to the amount that a bank expects to collect.
HOW IT WORKSIncome 5% 10% 20%
Loan Income 50,000$ 50,000$ 50,000$ Other Income 3,500$ 3,500$ 3,500$
Total Income 53,500$ 53,500$ 53,500$ Operating Expenses
Loan Servicing 500$ 500$ 500$ Provision for Loss 2,500$ 5,000$ 10,000$
Total Expenses 3,000$ 5,500$ 10,500$ Net Operating Income 50,500$ 48,000$ 43,000$ Non-Operating Expenses
Interest Paid to Depositors 500$ 500$ 500$ (Gain) Loss on Sale of Investment -$ -$ -$
Total Non-Operating Expenses 500$ 500$ 500$ Net Income 50,000$ 47,500$ 42,500$
NET LOAN CHARGE-OFFS
2004 2005 2006 2007 2008 2009 2010 2011 2012 20130.00%
0.20%
0.40%
0.60%
0.80%
1.00%
1.20%
1.40%
0.53%0.54%0.45%
0.51%
0.81%
1.21%1.14%
0.91%
0.73%0.60%
NET CHARGE-OFFS BY TYPE
Credit Card
First Mortgage
Second Mortgage
Business Loans
0.00%0.50%1.00%1.50%2.00%2.50%3.00%3.50%4.00%4.50%5.00%
200720082009201020112012
IASB/FASBJOINT PROPOSALMade at the request of the G20Will Change IFRS 9: Financial InstrumentsWill Replace IFRS 39: Recognition
Comment Deadline: 5 July 2013
WHY ADDRESS IMPAIRMENT?
The existing model delays recognition of credit losses until there is evidence of a credit loss event
HOW WOULD IT HELP?
Expected credit losses would be updated at each reporting date to reflect changes in credit quality
WHO IS AFFECTED?
All entities that hold financial assets or commitments to extend credit that are not accounted for at fair value
PROPOSALStage
I12 Month Expected
Credit Loss
Effective Interest on
Gross Carrying Amount
Stage II
Lifetime Expected
Credit Losses
Effective Interest on
Gross Carrying Amount
Stage III
Lifetime Expected
Credit Losses
Effective Interest on Amortized
Cost Carrying Amount
GAAP/IFRS CONVERGENCE GAAP and IFRS use Incurred Loss Model Both want Expected Loss Model
FASB Proposed Different ModelAn entity would not measure loss allowance
for any financial instrument using 12 Month Expected Credit Loss provisions in IASB proposal
IMPLICATION
• This is a great idea!
IFRS/FASB
• Are you kidding me?
Industry
CITED SOURCES http://www.ifrs.org/Alerts/ProjectUpdate/
Pages/IASB-publishes-revised-proposals-for-loan-loss-provisioning.aspx
http://www.ifrs.org/Current-Projects/IASB-Projects/Financial-Instruments-A-Replacement-of-IAS-39-Financial-Instruments-Recognitio/Impairment/Exposure-Draft-March-2013/Documents/ED-Impairment-Snapshot-March-2013.pdf
http://www.occ.gov/topics/credit/commercial-credit/allowance-loan-lease-losses.html
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