Yeah, it’s a deferred accounting technique that’s similar to the idea behind accounts payable / receivable.
For revenue due in the future, you book in a “sale” to accounts receivable, and then record the profit when the sale is delivered (in full or proportionally). That future loan revenue is an asset held by the bank until its actually received from the client and converted to current cash flow.
PCLs are effectively an offset to accounts receivable. I think it’s technically a negative asset and not a liability, but that’s not important. If everything goes right with a loan, the bank receives interest payable and the original principal. That was all logged as an expected receivable by the bank. When the bank chooses to believe more people will have difficulty paying their loans back, the bank increases PCLs to reduce the “expectation of owed income”. The idea is that the PCL figure is supposed to both be a backward-looking indicator of good loan creation behaviour at the banks, and a forward-looking signal to government or shareholders about a pending problem that the bank has identified.
Usually what actually winds up happening is the banks create too-high PCLs, which then are reversed later, magically re-creating those assets & profits in a future reporting period.
So, while PCLs are an important part of IFRS accounting for the finance sector, they also introduce a LOT of ability for banking executives to “manage” their overall level of taxable earnings. For example, if you don’t want to show huge earnings at a particular calendar year-end because of a proposed windfall tax on the banking sector…
Thanks for the explanation! That sounds incredibly exploitable. At least A/R has to be tied to actual billings, rather than pulled out of thin air ex ante.
Provisions for credit losses (PCLs). Not bad loans.
One is permanently impaired capital.
The other is a discretionary accounting technique that helps “manage” bank earnings / earnings expectations.
PCLs are a great way for the banks to influence outside forces by adjusting real profits to artificially show lower profits or even losses.
Say, if a government was considering…a windfall tax on excess profits…? Sure would be handy not to have them profits anymore.
How does this work exactly? The PCL is earmarked and effectively counts as bad debt?
Yeah, it’s a deferred accounting technique that’s similar to the idea behind accounts payable / receivable.
For revenue due in the future, you book in a “sale” to accounts receivable, and then record the profit when the sale is delivered (in full or proportionally). That future loan revenue is an asset held by the bank until its actually received from the client and converted to current cash flow.
PCLs are effectively an offset to accounts receivable. I think it’s technically a negative asset and not a liability, but that’s not important. If everything goes right with a loan, the bank receives interest payable and the original principal. That was all logged as an expected receivable by the bank. When the bank chooses to believe more people will have difficulty paying their loans back, the bank increases PCLs to reduce the “expectation of owed income”. The idea is that the PCL figure is supposed to both be a backward-looking indicator of good loan creation behaviour at the banks, and a forward-looking signal to government or shareholders about a pending problem that the bank has identified.
Usually what actually winds up happening is the banks create too-high PCLs, which then are reversed later, magically re-creating those assets & profits in a future reporting period.
So, while PCLs are an important part of IFRS accounting for the finance sector, they also introduce a LOT of ability for banking executives to “manage” their overall level of taxable earnings. For example, if you don’t want to show huge earnings at a particular calendar year-end because of a proposed windfall tax on the banking sector…
Thanks for the explanation! That sounds incredibly exploitable. At least A/R has to be tied to actual billings, rather than pulled out of thin air ex ante.
Weren’t these provisions required by the regulator?