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Credit risk recognition may become required of financial institutions

Jan 06, 2013 Walt Wojciechowski

A new proposal by the Financial Accounting Standards Board (FASB) hopes to increase transparency about credit risk. The model would demand banks, financial institutions and other organizations to publicly recognize credit losses, loans held as investments but never repaid, using a single "expected credit loss" measurement. The current model usually requires that loss be "incurred" before being recognized.

Five years ago, these outstanding loans and lack of debt collection contributed to the recession. The public had little to no knowledge of this credit risk before it was too late.

“The global financial crisis highlighted the need for improvements in the accounting for credit losses on loans and other debt instruments held as investments,” said Leslie Seidman, FASB chair, according to Reuters.

Under the new model, each period, financial institutions would be required to estimate cash flows they they don't expect to collect, measuring the possibility of both loss and full collection.

Reuters reported that the agency believes that by estimating these losses earlier on, U.S. financial institutions might be forced to boost loan-loss reserves by about 50 percent.

Comments on this proposal will extend well into 2013. According to the news source, if adopted, it would take take effect in one to two years.