Leading the Way is a column written by PricewaterhouseCoopers professional staff. It appears in the Business section of the Bangkok Post twice each month. The column provides specialised advice to corporate decision-makers in Thailand on global and local business trends.
This article appeared in the February 6, 2007 issue of the Bangkok Post.
By Boonlert Kamolchanokkul and Suwatchai Meakhaamnouychai
The Bank of Thailand (BoT) aims to get the banking industry ready for the adoption of International Accounting Standard 39 (IAS 39), particularly on loan provisioning. To accomplish this, the central bank issued new rules on loan provisioning in December 2006. To date, the Federation of Accounting Professions (FAP), the country's accounting governing body, has not issued a formal timeframe for the full adoption of IAS 39. Therefore, as loan provisioning is only one part of IAS 39, it may be fair to say that Thailand is only in the initial stages of IAS 39 compliance.
This article compares the principles of IAS 39 with the loan provisioning guidelines laid out by the central bank. In addition, it looks at the impact the new regulations may have on banks and their customers.
What is loan impairment under IAS 39?
Under IAS 39, a reporting entity has to assess objective evidence at each balance sheet date in order to determine whether a loan is impaired. An impairment loss is measured as the difference between the loan's carrying amount and the present value of estimated future cash flows, discounted at the original effective interest rate.
The process of estimating impairment considers not only low credit quality, but all credit exposures. Collateral must be taken into account when determining the loan's expected future cash flows. The amount of the impairment loss is recognised in the income statement.
How does this compare to the BoT's new regulations on loans?
While IAS 39 provides a theoretical concept, the central bank does not suggest any specific loan-loss model. Rather, it provides a guideline to be used in the loan-loss provisioning calculation, largely based on industry information and statistics.
Do the new rules indicate that the BoT is fully adopting IAS 39?
They indicate that the central bank is moving toward the full adoption of IAS 39 in the near future. In order for banks to be prepared for this, they would be advised to start properly implementing the central bank's rules with immediate effect.
The central bank announced it will take a three-phased approach to implementing its new regulations. In the first phase, which began in December, the new regulations were applied to all loans that were currently undergoing court procedures. The second phase, planned for June 2007, will apply the same regulations to loans that are six months overdue. In December 2007, the third phase will apply the regulations to loans that are three months overdue.
In comparison, IAS 39 is not limited in application to one single type of loan, such as NPLs, nor does it outline different implementation phases. In addition, under IAS 39, impairment occurs when the expected future cash flows of a performing loan do not have the same pattern as expected.
How will the new regulations affect banks?
Bank capital in the future will become increasingly vulnerable to increases in NPLs. The new rules will provide an incentive for banks to better handle and manage NPLs, to ensure that they are adequately capitalised. If a bank can't meet the challenges, it may face the risk of being unable to to meet the capital adequacy ratio required by the central bank.
Under the new regulations, the negative impact for small and medium enterprise (SME) and consumer mortgage loans will be similar. Therefore, banks are likely to be more selective in lending to these segments and may increase interest rates for higher-risk borrowers.
How will this affect the everyday borrower?
To comply with the guidelines, banks will have to ensure that they are properly capitalised and have good credit risk management systems.
They will encourage banks to implement better risk processes and credit approval systems in order to avoid unpleasant surprises. A well-run bank will know how to price loans to match the risk profiles of their different types of client groups.
However, the costs of such improvements, combined with the impact on capital resulting from adopting the guidelines, may place pressure on bank earnings. They might need to increase the margins on their loans, and in the end borrowers may suffer through increased interest rates.
Why did the BoT impose these guidelines?
The overall goal of controlling loans, and ensuring that banks have enough capital to cover these loans is to protect and strengthen Thailand's financial system. The central bank's current guidelines can be seen as stepping stones toward the eventual full implementation of IAS 39.
