Unintended Consequences Feared For New Rule on Loan Losses
Obviously, no bank could stay in business for very long if it lost money on every loan it made. Yet, new accounting rules set by the International Standards Accounting Board would force banks to post losses every time they grant someone a loan on the theory that a certain percentage of loans ultimately go bad. Critics are arguing that such measures are unnecessary and may have the unintended consequence of reducing the number of loans that banks make.
Critics fear that if banks have to post every new loan as a potential loss, then banks that are having a bad quarter will simply cancel or postpone loans they might otherwise make in order to avoid negative perception. Some banks might do so even in a strong quarter simply to increase the appearance of profitability. The result might be less trustworthy reports and lower transparency in lending. Ironically, profits would look higher, but long term economic growth would be hurt by less available financing. This could be especially harmful during an economic downturn.
Effective in 2018
These new accounting rules would affect over a hundred countries, but would not take effect until 2018. The need for the new loan loss rule was considered necessary due to the financial crisis of 2007-2008, in which banks were criticized for failing to recognize loans that were going bad earlier, thereby making it impossible for investors to protect themselves from bad lending policies.
Treating every loan as a potential loss at the outset makes that kind of fiscal blindness impossible. However, it also makes granting each new loan a threat to a bank’s bottom line, at least on paper and in the short term. The fear is that this will result in delaying or denying loans in order produce artificial profits on paper.
Some members of the Accounting Standards Board are suggesting alternative rules, such as a rule that would force a portion of the interest earned on each loan to be held in reserve in case the loan goes bad. This would accomplish the same goal of getting banks to keep more in reserve to cover their losses, but without creating incentives to deny loans or manipulate the books by strategic delays. It will be interesting to see if that or other alternatives to the currently planned loan loss rule are successfully introduced between now and 2018.