European banks already under pressure to strengthen capital ratios may have to hold off on distributing profit to shareholders because of new accounting rules on how loan losses are calculated.
The accounting requirement under the International Financial Reporting Standards, which goes into effect in 2018, would lower European banks’ capital levels by an average 2.7 percentage points, according to a study published Sept. 11 by Standard & Poor’s. That’s based on a survey showing banks expect their loan-loss reserves to rise by 50 percent, S&P said.
The new rules demand for the recognition of losses on loans when firms see early signs of trouble. Banks are nearing the end of a European Central Bank review of their books to see if they’re underreporting bad loans. Some firms increased reserves this year in expectation of the ECB’s findings.
“This new model will be on top of the cleanup they’re in the middle of doing,” said Jonathan Nus, one of the S&P study’s authors. “The ECB review will take care of the legacy losses and this new rule will take care of the future expected ones.”
Standard setters in Europe and the U.S. pushed for the accounting change after the 2008 financial crisis when lenders were criticized for being too slow to recognize losses as the global economy deteriorated.
The U.S. will probably complete its version of the loan-loss accounting change early next year, Nus said. The requirement under the U.S. Generally Accepted Accounting Principles is “likely” to become mandatory in 2019, according to S&P.
While the U.S. rule as proposed is tougher than Europe’s, its impact on capital ratios of U.S. banks will be smaller, according to S&P estimates. Even if loan-loss reserves doubled under the new standard, U.S. capital ratios would fall by 1.2 percentage points, the ratings company found.
European banks have larger loan portfolios than their U.S. counterparts, S&P said. In Europe, bank lending fills the majority of corporate-financing needs while U.S. companies borrow more from securities markets.
Banking regulators in the U.S. have also been pushing the firms to increase loan-loss reserves in the last few years. That has brought U.S. lenders closer to compliance with the new accounting standard, Nus said.