SOME DEBATABLE MATTERS IN ACCOUNTING TREATMENT OF CREDIT
RISK EXPOSURES AND CONTINGENT LIABILITIES AT COMMERCIAL
BANKS
L ILIYA R ANGELOVA , C HIEF A SSISTANT P ROFESSOR , P H D, CPA
U
NIVERSITY OF
N
ATIONAL AND
W
ORLD
E
CONOMY
– S
OFIA
, A
CCOUNTING AND
A
NALYSIS
D
EPARTMENT
Impact of the global financial crisis has led to a deterioration of the banks’ credit portfolio. The application of the prudence principle (conservatism, cautiousness) requires not allowing deliberate understatement of assets or overstatement of liabilities or expenses, because the information in the financial statements will not be reliable. Therefore, the rise of risk exposures in the banks should increase the cost of impairment of delinquent and problem loans. Under these conditions, it is essential for every commercial bank to develop own policy on classification of risk exposures, their adequate assessment and determining the amount of the accrued impairment expenses.
The purpose of this paper is to examine debatable matters in the accounting treatment of impairment losses, provisions and specific regulatory provisions in the Bulgarian commercial banks.
In carrying out its core business most banks suffer losses on the following risk exposures:
 all credit exposures classified as loans and advances to customers and banks, regardless of the used financial instrument that are carried at amortized cost;
 all credit exposures represented as contingent liabilities like issued guarantees, letters of credit, etc.
Application of accounting principle of prudence requires avoiding deliberate understatement of assets or overstatement of liabilities or expenses, because the information in the financial statements will not be reliable. In cases where the amount of the impairment corresponds to the expected credit losses, the bank can cover them without increasing its operating costs and disturbing the statutory capital adequacy requirements.
On the contrary, if the amount of the impairment loss recorded is smaller, it will reduce the financial results, respectively, the equity and the commercial bank may be sanctioned by the central bank.
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Accrued provisions for impairment losses are recognized in the financial statements of the banks prepared in accordance with IFRS.
At each date of preparation of financial statement the banks should review the loans and claims for any objective evidence of impairment. As a rule, impairment losses are accrued for exposures with objective indicators of impairment, in accordance with IAS 39
"Financial Instruments: Recognition and Measurement".
Occurred contingent assets and liabilities are treated and assessed continuously, in accordance with IAS 37 "Provisions, Contingent Liabilities and Contingent Assets".
Furthermore, risk exposures, representing credits and other claims of the bank measured at amortized cost, are subject to regulatory reports. In the case of Bulgaria, these are prepared in adherence of Ordinances №8 and №9 of the Bulgarian National Bank
(BNB). Commercial bank produces a Report on Classified Risk Exposures and Established
Specific Provisions, as of the last day of each quarter. The report is submitted to "Banking
Supervision" Department of BNB by the 15th of the month immediately following the end of the reporting period. Specific provisions for credit risk are deducted from the equity
(capital base), as per Ordinance №8 of BNB.
This paper is a theoretical research, as a result of which a comprehensive model is offered for analyzing risky credit exposures and allocating of provisions for impairment losses, as well as statutory provisions for credit risk. The proposed model includes in particular the following steps:
1.
Breakdown of the loan portfolio;
2.
Establishment of events of default and determining the risk classification group for regulatory purposes;
3.
Determining the probability of default (PD);
4.
Determining the Exposure at Default (EaD);
5.
Determining the amount of loss in case of default (LGD);
6.
Determining the expected loss (EL);
7.
Determining the loss confirmation period (LCP);
8.
Computing the provisions for impairment losses;
9.
Calculation of the specific regulatory provisions.
We believe that the proposed model will facilitate the banks in developing their own policy on classification of risk exposures to adequately evaluate and establish the amounts of impairment losses, provisions and specific regulatory provisions.
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