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New accounting standard could hit banks' book value and capital, says report

The introduction of a new accounting standard could increase the amount that European banks will have to set aside to cover the cost of loans on their books by around 34%, hitting their book values and capital holdings, according to Barclays. 02 Sep 2015

A new accounting standard, International Financial Reporting Standard (IFRS) 9  (registration required), is due to come into force on 1 January 2018. In a new report, seen by Out-Law.com, Barclays analysed how the change would affect 27 of Europe's largest banks.

Caixa, UBI and Standard Chartered appeared "most vulnerable" to the effects of the new rules, with "an erosion of CET1 [common equity tier one] ratios of 130-170 [base points]", according to the report. CET1 consists of high quality assets, such as shareholders' equity and disclosed reserves.

Caixa’s CET1 ratio would fall by about 1.7% as a result of the higher loan losses triggered by the rules, according to the Barclays report; while Standard Chartered’s and UBI’s ratios would fall by about 3%. Credit Suisse, UBS, Virgin Money and Nordea are likely to see the least impact, it said.

"Longer term, we are concerned that IFRS 9 could result in higher earnings volatility for the sector," Barclays said.

IFRS9 was issued by the London-based International Accounting Standards Board (IASB) and forms part of the body’s response to the global financial crisis. Amongst its provisions, it will require firms to account for expected credit losses at the point that they first recognise financial instruments, and to recognise full lifetime expected losses at an earlier stage.

The IFRS rules are designed to be used by listed companies when compiling accounts, in order to make them understandable and easy to compare across international boundaries. More than 100 countries currently require or allow the use of IFRS, although the US is a notable exception. The US Generally Accepted Accounting Principles (US GAAP) are overseen by the Financial Accounting Standards Board (FASB).

The new standard is designed to address concerns which emerged following the global financial crisis that banks were unable to account for losses until they were incurred, even when it was apparent to them that they were going to experience those losses. Under IFRS9, the 'impairment model' used by banks will change from 'incurred loss' to 'expected loss', requiring them to set aside sufficient capital to cover expected losses over the next 12 months. In addition, they will be required to record lifetime expected losses if credit risks increase significantly.

The UK’s Local Authority Pension Fund Forum published a legal opinion this week from George Bompas QC, saying that the IFRS9 rules will still not give a "true and fair" view of banks’ financial position.