Banks told to flag risky loans even before these go bad

Local banks will now be required to toughen their accounting standards on risky loans — even before borrowers actually default on their payment — after the Bangko Sentral ng Pilipinas approved new guidelines on “expected credit losses.”

In a statement, the central bank said the new Philippine Financial Reporting Standards provisions require banks to classify certain performing but risky assets as “impaired” in order to give their stakeholders a better, more conservative picture through its financial statements.

“The model requires early recognition of allowance for credit losses even before the default or nonpayment of the borrower,” the central bank said, explaining that this approach had already been adopted earlier by regulators in its prescribed credit risk guidelines.

“The BSP’s earlier issuance amending the definitions of past due and nonperforming loans likewise paved the way for the implementation of the expected credit loss methodology in booking allowance for credit losses,” it added.

Speaking on condition of anonymity, a central bank official familiar with the policy said banks had long been mandated by regulators to recognize risky assets — like loans that are in danger or going bad or bonds whose issuers may default — but noted that accounting practices prior to this new policy required actual evidence of default before classifying them as bad assets.

“So this new policy mandates the alignment of the country’s accounting practices with the more conservative rules of the central bank on recognizing risky assets,” the official said. “It’s a more proactive policy.”

The central bank said that the policy — which was recently approved by the Monetary Board — “provides the overarching governance overlay on the adoption of the standard.”

“In particular, the board of directors is required to assess the impact of [the new financial reporting standards] on business strategies and risk management systems to be able to adopt appropriate policies and control measures that will ensure integrity of the reporting process,” according to the statement.

“The Bangko Sentral also expects [financial institutions] to exercise sound professional judgment in implementing the provisions of the standards considering that these are largely principles-based,” it added.

Meanwhile, “in keeping with the principle of proportionality,” the central bank said that smaller banks with simpler operations “are expected to adopt simple loan loss methodologies fundamentally anchored on the principle of recognizing expected credit losses.”