On April 30, the IIF Senior Accounting Group (SAG) submitted its response letter on the Guidance on Accounting for Expected Credit Losses ("ECL") (the "Guidance") consultative document issued by the Basel Committee. ECL accounting for loan losses (and thus for provisions) as now promulgated by the International Accounting Standards Board and as expected to be proposed by the US Financial Accounting Standards Board will require extensive use of internal modeling, including banks' macroeconomic projections and other forward-looking information, covering the entire life of each loan. The Guidance will, when finalized, aim to promote high-quality, robust and consistent implementation of such ECL accounting, both under IFRS and under US GAAP, as well as other accounting systems if relevant. The Guidance reflects the Committee's concern that the transition to the new ECL accounting from previous incurred-loss needs to be based on shared expectations across the industry, auditors, investors, and supervisors. While the SAG shares the Committee's expectation that banks will achieve high quality implementation of the new accounting requirements, the Guidance as currently drafted raises a number of concerns on which detailed comments and drafting suggestions are provided. '
In its response, the SAG suggested that the Basel Committee (the "Committee") ' consider in finalizing the Guidance the following primary issues, as well as a number of other detailed issues:
- The Guidance should focus on achieving the overarching objective of an ECL accounting model, which is to ensure that credit losses are recognized in accordance with accounting standards. The Guidance should clarify not only how credit risk management should underpin the financial reporting but also areas where differences are expected between accounting and ' prudential treatments.
- To help focus the content of the final Guidance on its purpose, the SAG argues that the Committee should consider removing detailed information about credit risk practices and management, which appear to create new standards for credit risk management and practice, and acknowledge that risk-management tools are different for retail and wholesale counterparties.
- While the Guidance acknowledges that financial reporting must be unbiased and neutral, so that gains and losses are recognized symmetrically, this point together with noting the importance of other fundamental accounting concepts such as materiality should also be clearly stated up front for the avoidance of any doubt.' This implies that some of the conservatism of prudential risk-management requirements needs to be adjusted when basing ECL analyses on existing risk management.
- Overall, the structure of the document and its drafting should be tightened to ensure it is internally consistent and clearly defines terms, and so it is understandable to its intended audience, including finance and risk personnel in banks, as well as supervisors and auditors.
In addition to these overarching issues, this comprehensive response letter incorporates specific drafting suggestions for the Guidance itself on issues such as the use of forward-looking information in the context of behavior scores; definition of appropriate segmentation; the ability to incorporate forward-looking' information at an individual or collective basis; the use of information such as changes in pricing in determining whether there has been a significant increase in credit risk; how banks propose to approach proportionality and materiality; and the scope of the guidance on credit risk management practices and regulatory capital methodologies.