The accounting standard setters – the Financial Accounting Standards Board (FASB), the International Accounting Standards Board (IASB), and the SEC – should review accounting standards to determine how financial firms should be required to employ more forward-looking loan loss provisioning practices that incorporate a broader range of available credit information. Fair value accounting rules also should be reviewed with the goal of identifying changes that could provide users of financial reports with both fair value information and greater transparency regarding the cash flows management expects to receive by holding investments.

Certain aspects of accounting standards have had procyclical tendencies, meaning that they have tended to amplify business cycles. For example, during good times, loan loss reserves tend to decline because recent historical losses are low. In determining their loan loss reserves, firms should be required to be more forward-looking and consider factors that would cause loan losses to differ from recent historical experience. This would likely result in recognition of higher provisions earlier in the credit cycle. During the current crisis, such earlier loss recognition could have reduced procyclicality, while still providing necessary transparency to users of financial reports on changes in credit trends. Similarly, the interpretation and application of fair value accounting standards during the crisis raised significant procyclicality concerns.

Improve Accounting Standards

1. We recommend that the accounting standard setters clarify and make consistent the application of fair value accounting standards, including the impairment of financial instruments, by the end of 2009.

The G-20 Leaders directed the accounting standard setters to improve the standards for the valuation of financial instruments and to reduce the complexity of financial instrument accounting. The International Accounting Standards Board (IASB) undertook a project to develop by July 2009 a new financial measurement standard that would replace International Accounting Standard (IAS) 39, Financial Instruments: Recognition and Measurement, the fair value measurement standard under International Financial Reporting Standards (IFRS), and reduce the complexity of accounting standards.

In addition, the Financial Accounting Standards Board (FASB) and IASB have provided additional guidance on fair value measurement. The standard setters are also evaluating the recommendations provided by the Financial Crisis Advisory Group ('FCAG'), a high level advisory group that standard setters established in December 2008.

In response to FASB's recent changes to its impairment standard for debt securities, the IASB has committed to making improvements to its own impairment requirements as part of its comprehensive financial instrument project, slated for an exposure draft by October 2009. Moreover, the IASB has also committed to work with FASB as part of its comprehensive financial instrument project to promote global consistency in impairment approaches.

2. We recommend that the accounting standard setters improve accounting standards for loan loss provisioning by the end of 2009 that would make it more forward looking, as long as the transparency of financial statements is not compromised.

In its April 2009 report addressing procyclicality in the financial system, the FSB determined that earlier recognition of loan losses by financial firms could have reduced the procyclical effect of write-downs in the current crisis. The FSB recommended that the accounting standard setters issue a statement that the current incurred loss approach to loan loss provisions allows for more judgment than banks currently exercise.

The FSB also recommended that the accounting standard setters give consideration to alternative conceptual approaches to loan loss recognition, such as a fair value model, an expected loss model, and dynamic provisioning.

As directed by the FSB and G-20 Leaders, accounting standard setters continue to evaluate the issue of loan loss provisioning, including developing an expected loss model to replace the current incurred loss model.

3. We recommend that the accounting standard setters make substantial progress by the end of 2009 toward development of a single set of high quality global accounting standards.

The G-20 Leaders agreed that the accounting standard setters should make substantial progress toward a single set of high quality global accounting standards by the end of 2009. The IASB and FASB have engaged in extensive efforts to converge IFRS and U.S. Generally Accepted Accounting Principles (GAAP) to minimize or eliminate differences in the two sets of accounting standards. Last year, the IASB and FASB reiterated their objective of achieving broad convergence of IFRS and U.S. GAAP by the end of 2010, which is a necessary precondition under the SEC's proposed roadmap to adopt IFRS. Currently, the SEC is considering comments submitted on its proposed roadmap that sets forth several milestones that could lead to the eventual use of IFRS by all U.S. issuers.