Rule Change Would Shift Loan-Loss Accounting

U.S. and international accounting rule makers have agreed in principle on a new standard for recording loan losses that may require banks to book some losses more quickly.

Under the new plan, banks and other financial companies would shift to an "expected-loss" model, under which they would book losses and set aside loan-loss reserves based on future projections of losses. That would differ from the current system, known as an "incurred-loss" model, which requires evidence that a loss actually has occurred before the loss can be recorded.

A move to using future loss projections would have the effect of accelerating the booking of losses.

Some critics have said the current system led banks to record losses on a too-little-too-late basis during the financial crisis. In response, the U.S. Financial Accounting Standards Board and the International Accounting Standards Board in January proposed a shift to the expected-loss model. They reached agreement on their approach in a joint meeting last week in London, representatives of both boards said.

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Under the system agreed to by the two accounting rule makers, companies would book loan losses upfront if the cash flows aren't expected to be collected within the next 12 months. Further losses over the loan's lifetime would be recorded if banks determine the loans' credit quality has deteriorated to a "more than insignificant" extent and there is enough of a possibility of default that the contractual cash flows from the loan may not be recoverable.