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FRC backs Turner's cycle reserve plans

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23rd Mar 2009
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The Financial Reporting Council (FRC) said it supports Lord Turner's suggestion of an 'economic cycle reserve' (ECR) to bolster bank balance sheets.

The FRC has promoted the idea of an ECR both within the UK and through the International Stability Forum.

Just before the Turner review was published, the Accounting Standards Board (ASB) held a meeting of 40 representatives including investors, accountancy firms, banking industry representatives and regulators to discuss counter-cyclical measures.

An ECR would be built up during the upswing of the economic cycle through an appropriation from retained profits. It would be an undistributable balance sheet reserve, limiting a bank’s ability to pay dividends and make share buybacks during the upswing and available to be released in the bad times. The FRC has described it as a 'rainy day' provision.

The consensus view of the meeting was:

  • There is support for economic cycle reserving if it is agreed between the bank and its regulator;
  • Provisions should not be implemented in a way that impacts the P&L of a company.
  • The International Accounting Standards Board (IASB) should look at the requirements of IAS 39, particularly the relative merits of the incurred loss and expected loss models.
  • There are likely to be unforeseen circumstances affecting all the potential solutions being considered.

Ian Mackintosh, Chairman of the ASB, set out two routes to implementing 'dynamic' provisions, or reserves, that would help alleviate downturns in the economy: a change in accounting requirements or a change in regulatory requirements. From an accounting standard setter’s point of view, the latter was more advisable.

Ian Wright, Director of Corporate Reporting at the FRC, explained that ECR required judgement to be applied by the management of the bank and the regulator when setting the reserve levels, and for ongoing monitoring of that initial judgement. It allowed a holistic view to be taken of a bank’s balance sheet and the amounts that should be set aside in the good times to help it survive the bad.

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