Regulatory challenges ahead: while it has been another solid year of growth for the five major Australian banks, significant challenges lie ahead including the divergence of regulation and accounting regimes potentially affecting profit and loss volatility, according to Ernst & Young's annual banking results analysis

Australian Banking & Finance, Nov 30, 2004

International Financial Reporting Standards (IFRS) and Baset II will substantially change the way banks account for potential loan tosses.

The new IFRS standard will only allow loan Losses to be provided for once they have been incurred, so in a downturn the banks could report large Loan Losses.

As a percentage of bad debt expense, general provisions are now around two and a half times larger than 10 years ago.

Basel II regulations will require banks to assess potential losses based on the expected Losses that will occur through the whole economic cycle.

Banks may therefore be required to maintain two sets of records as to potential loan losses, one for accounting purposes and one for APRA.

According to Andrew Price, Ernst & Young national head of banking, the AASB and APRA need to consult on a common approach.

"The potentially worrying component of the changes for the Banking sector in the key areas of loan provisioning, securitisation and the treatment of hybrid equity, is a divergence between the accounting standards and the prudential standards," he said.

"The time has come therefore for the AASB and APRA to agree on one approach that can meet both of their needs. "Banks resources are better spent on reducing risk rather than dealing with different ways to record the Losses. "The fact that European banks have been able to lobby the EU Accounting Regulatory Committee for some key concessions in hedge accounting may also disadvantage Australian banks as they will have greater volatility in their results compared to their European counterparts.

"On another note, these changes may present the banks with some capital management opportunities.

"This is particularly important when you consider how significantly this sector now is with the ASX 200, given the removal of News Corp, and therefore it has the ability to have an impact on a Large numbers of investors."