Banks baffle investors as art meets science in accounting rule

LONDON: Like the myriad approaches governments are taking to tackle the coronavirus crisis, the way the world’s top banks are calculating their potential losses also differs widely, with puzzling outcomes for investors.

These discrepancies are rooted in the interpretation of new accounting rules called IFRS9, which have been designed to promote transparency and stability by making banks account for loan losses earlier.

But rather than solving problems seen during the 2008-9 financial crisis, when markets were blindsided by a sudden deterioration in bank balance sheet health, IFRS9 is confounding the same investors they are meant to help.

While the rules aim to provide a more realistic and timely picture of bank exposures, some have described their application as more art than science. Critics go further; complaining the system is complex, opaque and vulnerable to abuse.

“It makes a mockery of financial reporting if banks can report better numbers simply by assuming a more benign outlook — either intentionally or unintentionally,” Ed Firth, banking analyst at KBW, told Reuters.

A Reuters analysis of first quarter regulatory filings highlights the extent to which banks are basing their estimates of how bad loans will rise on differing economic forecasts.

For example, Barclays used an 8 percent fall in UK GDP and 6.7 percent unemployment as its baseline scenario for 2020, while fellow British lender Lloyds Banking Group had a 5 percent contraction in GDP and 5.9 percent unemployment.

Barclays booked a larger-than-expected 2.12 billion pound ($2.63 billion) credit impairment charge, while Lloyds set aside 1.4 billion pounds. Diverging economic forecasts don’t explain all of that variation, but they make it harder for investors to understand the banks’ models.

Lloyds’ Chief Executive Antonio Horta-Osorio said last week that while his bank’s 2020 forecast was comparatively less gloomy, its prediction for 3 percent growth in 2021 was more realistic.

“We are assuming a prudent recovery in the second year of 3 percent only, so our combined impact on the two years is a negative 2 percent GDP,” Horta-Osorio said.

Barclays, which expects a 6.3 percent bounce back in 2021, said its forecast “reflects the most recent economic forecasts available in the market combined with internal assumptions.”

Filippo Alloatti, senior international credit analyst at Federated Hermes, said he was undecided on whether IFRS9 was a help or a hindrance to bank investors.

“We knew IFRS9 was untested in a recessionary environment. It gets complicated when banks are using a ‘scenario cocktail’ and not disclosing the relative weighting of each scenario,” he said.