WASHINGTON (7/10/13)--Credit unions are concerned that loan loss expenses created by the International Accounting Standards Board's proposal to transition to an expected loss model for loans and other financial instruments could substantially deplete some credit unions' regulatory capital levels, the World Council of Credit Unions wrote in a letter to IASB.
The letter follows the recent release of IASB's Financial Instruments: Expected Credit Losses exposure draft. The World Council opposes this exposure draft, as proposed, and urged the IASB to either retain an incurred credit loss model or make significant changes in the final version of the standard to address credit union concerns.
This depletion of regulatory capital that could occur in an expected loss model would likely increase credit unions' loan loss expenses, even though credit unions' underlying economic credit risk exposures, and total amount of reserves and allowances held to protect the institution and its members against losses, would not be changed as an economic matter, World Council Chief Counsel Michael Edwards wrote.
"Unlike joint-stock company banks, credit unions must rely primarily on earnings retention to build capital and have limited, if any, means of raising additional capital," Edwards explained. This capital level depletion could make impacted credit unions subject to mandatory supervisory remedial actions such as "Prompt Corrective Action" rules, he added.
Retaining an incurred loss approach, especially with respect to smaller, community financial institutions, could help remedy this potential regulatory capital issue, Edwards said. If, however, the IASB decides the proceed with an expected credit loss approach, World Council supports the IASB's proposed "Stage 1" approach that limits expected credit losses to a 12 months lookout period until an instrument experiences "significant deterioration in credit quality" such as being in arrears for more than 30 days.
Other potential actions that could improve the IASB proposal for credit unions include:
Allowing a long transitional period for phase-in of the new standard so that credit unions have sufficient time to build up additional loan loss reserves;
Not requiring the discounting of expected future cash flows at the credit-adjusted effective interest rate; and
Allowing jurisdictional accounting authorities and/or regulators the option to establish simplified credit loss methodologies for small financial institutions, especially those in developing countries and/or those with limited staff resources, for whom full compliance with the proposed expected credit loss model would be an excessively burdensome compliance requirement.
For the full World Council letter, use the resource link.