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Dynamic Provisioning (Loan Loss Provisioning)

Date recorded:

The staff informed the Board that the purpose of this session was to have a general discussion on the topic of loan loss accounting and whether this topic should constitute a separate work stream in the financial instruments project.

The staff noted that to understand the models proposed for possibly replacing the IAS 39 incurred loss model, further meetings with constituents were necessary, particularly with the Spanish Central Bank as their model is considered by some constituents as a possible starting point for improving the guidance on loan loss provisioning. It was also emphasised that 'through the cycle' provisioning would require recognising impairments above an expected loss due to the duration of an economic cycle (10-15 years) compared to an average loan maturity.

The staff further noted that the term 'dynamic provision' is not well defined and different people think of different models when talking about dynamic provisioning.

Board members asked why the expected loss on day one would not be factored into the transaction price. Staff confirmed that theoretically all loss expected on the date of transaction should be factored into the transaction price. The staff said that if impairments are higher, the unwinding of them lead to a higher effective interest rate in the future, which under certain scenarios could lead to a pro-cyclical effect. It was noted that under the current IAS 39 model the effective interest rate is kept constant and the cash flows are adjusted.

Board members had some discussions on what impairment represents, technical considerations, and whether an expected loss model is closer to fair value. None of those discussions were conclusive.

In the end the boards decided that the issue of impairment was important enough to justify it being established as a separate work stream in the financial instruments project.

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