FASB Reversal a Major Step Toward International Convergence

The FASB has made a major compromise in the area of impairment of financial instruments. Full details will be released later, but this is a major concession to U.S. and European banks. It is also a major step toward convergence of U.S. accounting rules with IFRS and the end to what what previously called a "religious war" over fair value accounting. As well, political influence over accounting may be resolved by the compromise.

This new FASB approach is similar to the International Accounting Standards Board’s model in IFRS 9. FASB has agreed that at least some assets should qualify for cost accounting, whereas banks were forced to use a fair value model for all loans under the new rules. Existing rules forced fair value on portions of banks’ loan portfolios.

The FASB’s original proposal was opposed by the banking industry as being pro-cyclical (making problems worse as business cycles worsened). Banks say that proposed the fair value approach is a danger to the survival of marginal financial institutions that could have their capital called by bank regulators because the rules have and would continue to force banks to take large and inappropriate write-downs on temporary market declines. They also lobbied that the rules would hurt lending and unfairly reduce banks' book value. They argued that banks would not make loans if the value of the loan could be written down immediately due to temporary market fluctuations.

Supporters of the FASB fair-value proposals say it would have improved transparency and unmasked potential weaknesses at banks. Proponents of fair value accounting, including the CFA Institute, argue it is what is needed to make the financial statements of banks reflect their true financial positions and operations more clearly to investors.

FASB said that financial statement users, including preparers, auditors and others would prefer to have loans held for collection recorded on the balance sheet at amortized cost, but with a more robust impairment test.

The FASB will go back to users for input toward an impairment model for loans. The original proposal required a fully fair value-based approach that the banks have lobbied against for years. The new approach would recognize a portion of the estimated loan losses over time unless greater losses are expected in the foreseeable future, in which case that larger floor amount would be recognized currently. Some loans, including loans traded actively by banks instead of held to collect payments will be valued at market prices.

The changes are partly the result of a fierce lobbying campaign by the American Bankers’ Association and others and seen as a major victory for the banking industry. However it was not solely the banks in opposition to the proposals. The FASB reported an overwhelmingly negative reaction to its proposal from companies and investors, who wrote more than more than 2,800 comment letters.