FASB Update
While there are some in the media that are suggesting this is a sudden reversal of the decisions made last April, it is actually part of a process that started years ago. Both the FASB and the International Accounting Standards Board (IASB) have a long term stated objective that the primary accounting for ALL financial instruments including liabilities should be fair value. They are now in the first steps of a very long process on how to exactly do this.
The initial recommendation is that fair value be the default accounting for financial instruments on the balance sheet. However, other factors such as the institution’s business model (buy and hold versus trade, for example) and characteristics of the financial instrument (cash flow volatility, derivative, market activity), along with other factors will determine whether the unrealized gain or loss is recorded in the income statement or the balance sheet via other comprehensive income. These determining factors have not been laid out in detail yet as they are at the conceptual stage. It very well may be that they are the same concepts used now for securities (primarily based on intent) with a few twists. What is happening now is the first step in a long process on the best way to do this, which includes seeking comments from the industry. The ABA came out quickly with a letter to the FASB with their opinions.
This is an important issue that we will follow closely and may ultimately result in significant changes to accounting for financial instruments. It will also probably force regulatory changes to capital requirements and calculations. However, it is not a sudden reversal of the April decision that changed how fair value is determined in inactive markets or how it is used for impaired securities. It simply is the first step in implementing a long stated common objective of the FASB and IASB.
As fair values become more part of the accounting process for less active financial instruments, it will put more of the spotlight on pricing models that value credit such as loans. I’m very curious to see if the loan fair value models used by many big banks that resulted in fair values of their entire loan portfolios (including commercial, construction, land development loans and consumer) in the high 90s for the last several quarters receive a little more attention.
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