The Financial Accounting Standards Board's (FASB) final version of its "Current Expected Credit Losses" standard under U.S. generally-accepted accounting principles (US GAAP), which FASB plans to issue in the fourth quarter of this year, is likely to require credit unions to increase their loan loss reserves significantly once it is phased in. FASB's new rules would move US GAAP's credit loss accounting from the currently applicable "incurred loss" approach to a forward-looking "expected loss" approach where an institution estimates its future losses and recognizes them on an accounting basis even if those losses have not yet occurred.
Although FASB seems set on finalizing its proposal, there is another expected credit losses standard developed by the International Accounting Standards Board (IASB) called International Financial Reporting Standard 9 which would be less burdensome on credit unions and should also arguably be the expected credit loss standard under US GAAP.
IASB finalized its expected credit loss standard in April 2014 and it will apply to credit unions in Canada, Australia and most other jurisdictions outside of the United States. Whereas FASB's expected credit loss approach would recognize expected lifetime credit losses on all loans, IASB's expected credit loss standard is generally considered less stringent because it only recognizes expected losses on performing loans if those losses are likely to occur within the next 12 months. For loans that have experienced significant arrearage (such as being 30 or more days in arrears), IASB's rules recognize lifetime expected credit losses in a way similar to FASB's proposed standard, even if the loan later becomes re-performing.
IASB's expected credit loss standard should also arguably be the expected credit loss standard under US GAAP, because in 2002, FASB and IASB entered into the "Norwalk Agreement" which committed to boards to "converge" US GAAP and IFRS by adopting identical accounting standards in order to reduce cross-border accounting differences. Under this agreement FASB and IASB should have worked together on a single expected credit loss standard. FASB, however, decided in 2012 that it did not agree with the IASB's approach and resolved to develop a more stringent expected credit loss standard for US GAAP.
To illustrate the practical differences between the IASB and FASB approaches, a staff report delivered at the July 2013 joint FASB-IASB board meeting estimated that FASB's rules would be much more expensive for financial institutions to implement. According to the staff report, FASB's approach to expected credit loss accounting would likely require US financial institutions to increase their loan loss reserves by up to 40% compared to currently applicable US GAAP. In contrast, the IASB's rules could result in U.S. financial institutions possibly reducing their loan loss reserves compared to currently applicable US GAAP.
FASB seems intent on finalizing its expected credit loss standard despite the split with IASB and despite the fact that U.S. credit unions generally performed well during the financial crisis using an incurred credit loss accounting standard. The Federal Credit Union Act requires federally insured credit unions with more than $10 million in assets to follow US GAAP, meaning that most U.S. credit unions will have no choice but to adopt the FASB's standard if it comes into force.
Retaining an incurred credit loss standard may not be feasible for U.S. credit unions in the long term, but that does not mean that the FASB's expected credit loss rules are the only way forward. If given a choice, credit unions in the United States would almost certainly prefer the IASB's expected credit loss standard because it uses a 12 month lookout period for expected credit losses on performing loans instead of recognizing lifetime expected credit losses on those items.
If FASB finalizes its expected credit loss standard without major changes, perhaps the best chance for the U.S. credit union movement to limit the regulatory burdens associated with expected credit loss accounting would be to advocate for FASB to renew its commitment to the US GAAP-IFRS convergence project and incorporate the IASB's expected credit loss standard into US GAAP.
Michael S. Edwards is Vice President and General Counsel for the World Council of Credit Unions. He can be reached at 202-508-6755 or [email protected].
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