Sound Practices for Loan Accounting, Credit Risk Disclosure and Related Matters

October 1998

Executive summary

This document provides guidance to banks, banking supervisors and accounting standard-setters on recognition and measurement of loans, establishment of loan loss allowances, credit risk disclosure and related matters. It sets out banking supervisors' views on sound loan accounting and disclosure practices for banks. The document also serves as a basic framework for supervisory evaluation of banks' policies and practices in these areas.

Various international bodies, including the Basle Committee, have called for progress in accounting and disclosure practices for banks' lending business and related credit risk. Accounting treatments generally, and loan accounting treatments specifically, can significantly affect the accuracy of financial and supervisory reporting and related capital calculations. Moreover, sound accounting and disclosure practices are essential to ensure the enhanced transparency needed to facilitate the effective supervision and market discipline of financial institutions. In addition to the Basle Committee, the G-7 Finance Ministers, G-10 central bank Governors and international agencies such as the International Monetary Fund (IMF) and the World Bank have called for progress in this area.

The paper begins by stating the overall objectives of the Basle Committee in addressing the topic of sound practices for loan accounting and disclosure. It then summarises key terms and ties this guidance to the credit risk management process. The paper then provides guidance on sound practices with respect to key loan accounting issues, such as the initial recognition and measurement of loans, subsequent measurement of impaired loans, the establishment of loan loss allowances, income recognition and issues relating to troubled debt restructurings. Moreover, the paper presents sound disclosure practices for loan portfolios, troubled loans, loan loss allowances and related risk management practices. The paper concludes with a brief discussion of the role of supervisors in assessing a bank's management of asset quality and the adequacy of loan loss allowances.

Three primary concerns of supervisors are a) the adequacy of an institution's process for determining allowances, b) the adequacy of the total allowance and c) the timely recognition of identified losses through either specific allowances or charge-offs.

The publication of this paper is a component of the Committee's long-standing work to promote effective banking supervision and safe and sound banking systems. It complements the Basle Core Principles in the field of accounting and disclosure for banks' lending business and related credit risk. International implementation of the guidelines in this paper should help achieve enhanced bank accounting policies and practices, which are consistent with sound risk management practices, in both G-10 and non-G-10 countries, as well as increased convergence of such policies and practices across banks and countries.