Basel Committee Addresses New Lease Accounting Standards FAQs

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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