The Basel Committee issued responses to frequently asked questions related to the changes to lease accounting promulgated by the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB).
In 2016, the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) revised the accounting for lease transactions. Both standards are effective as of January 1, 2019 for calendar year-end entities, with early adoption permitted within the standards. While there are some differences between the IASB and FASB versions of the new lease accounting standards, they are consistent on the most fundamental change – they both require that most leases will be reflected on a lessee’s balance sheet as an obligation to make lease payments (a liability) and a related right-of-use (ROU) asset (an asset). The following questions arise for banks in their capacity as lessees.
Most intangible assets are deducted from regulatory capital, while tangible assets generally are not. Is the lessee’s recognised asset under the new lease accounting standards (the ROU asset) an asset that is tangible or intangible?
For regulatory capital purposes, an ROU asset should not be deducted from regulatory capital so long as the underlying asset being leased is a tangible asset.
Where the underlying asset being leased is a tangible asset, should the ROU asset be included in risk-based capital and leverage ratio denominators?
Yes, the ROU asset should be included in the risk-based capital and leverage denominators. The intent of the revisions to the lease accounting standards was to more appropriately reflect the economics of leasing transactions, including both the lessee’s obligation to make future lease payments, as well as a ROU asset reflecting the lessee’s control over the leased item’s economic benefits during the lease term.
Where the underlying asset being leased is a tangible asset, what risk weight should be assigned to the ROU asset for regulatory capital purposes?
The ROU asset should be risk-weighted at 100%, consistent with the risk weight applied historically to owned tangible assets and to a lessee’s leased assets under leases accounted for as finance leases in accordance with existing accounting standards.
“This is very bad news,” said Bill Bosco. “Why did they not look at the true economics of operating leases being executory contracts? The ROU asset disappears in a liquidation as the tangible underlying asset is returned to the lessor. There should be no need for capital due to that fact. At present operating leases do not require regulatory capital. Just because the FASB/IASB call something an asset does not mean it is an asset that must be liquidated – what if they decide to capitalize utility contracts (like to receive electricity or telephone services) – they could do it and then would the right to the service attract capital?”
“This will further restrict banks’ ability to lend and help spur the economy,” Bosco continued. “It should especially hurt banks in need of capital – Deutsche Bank was recently in the news saying it will seek to raise 8 billion euros ($8.5 billion) through a share sale, a move to shore up the German lender’s capital. I estimate that this negative and erroneous regulatory capital decision will add another capital need of 1 billion euros for Duetsche Bank.”
Bosco predicted this as an issue in a previous article published in Monitor.
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One Reply to “Basel Committee Addresses New Lease Accounting Standards FAQs”
This is an advocacy issue for all the bank lessors as it will hurt their parent. Mostly it is a real estate operating lease issue affecting banks with large branch networks. The OCC and FED traditionally follow the FASB’s definition of what is an asset. The operating lease ROU asset is a new type of asset. The ROU asset should not require capital but the bank regulators refuse to change their thinking. This may be a bigger problem in the future as the FASB moves away from risks and rewards to a control concept to define what an asset is. Risks and rewards is the way commercial law and IRS tax law define assets. I heard BASEL thinks its decsion is not material BUT I say just because something wrong is not material does not make it acceptable. Also ask any bank CFO if they think it is not material and they will say it is as capital is a large issue these days. In my opinion because the IASB did not follow the FASB in maintaining the distinction between operating and finance leases for lessees, BASEL did not give any relief for operating lease assets as an IFRS bank will not have the information to support which ROU assets are operating lease assets. The FASB clearly made the decision to break out operating lease ROU assets so that the US bank regulators could continue to treat operating lease as capital free. Please push them to do so – they have the power to have a different risk weight rule for US banks’ ROU assets and that should be 0% risk weighting.