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On March 20, the Bank of England and European Central Bank (ECB) provided guidance to banks on how to follow accounting rules in evaluating loans to borrowers affected by the COVID-19 crisis.
The new IFRS 9 accounting standard, implemented in most of the world outside the U.S., requires banks to set aside loan loss allowances against all future expected losses for loans to borrowers who are categorized in high-risk groups. For borrowers in the low-risk group, the standard only requires banks to set aside allowances for 12 months of expected losses.
Most borrowers are now in the low-risk group. But IFRS 9 could require banks to downgrade borrowers into a high-risk group if they miss payments because of the crisis. Such downgrades would affect banks’ capital negatively, making it harder for them to keep lending or provide forbearance to affected borrowers.
In different ways, UK and EU regulators gave guidance to banks to be flexible in such cases. Specifically, they said that banks should take into account government relief measures in evaluating borrowers and calculating expected losses on their loans. The guidance says that those relief measures, such as payment holidays or loan guarantees, should not automatically lead banks to move borrowers from 12 months of expected losses to lifetime expected losses.
The Bank of England said that, when firms calculate future losses, it expects they will “reflect the temporary nature of the shock, and fully take into account the significant economic support measures already announced by global fiscal and monetary authorities.”
The ECB said it would “exercise flexibility” regarding the classification of borrowers as unlikely to pay when banks call on new COVID-related public guarantees and on borrowers covered by legally imposed payment moratoria.
In the U.S., the Financial Accounting Standards Board (FASB) implemented the Current Expected Credit Losses (CECL) standard for large banks at the beginning of this year. Like IFRS 9, CECL provides a forward-looking framework for banks’ calculation of expected losses. Bankers and some U.S. regulators this week called on FASB to loosen or delay the standard. FASB has said that is the regulators’ call.