Ireland and Iceland in Crisis B: Decreasing Loan Loss Provisions in Ireland

Abstract

All public companies in the European Union, including Ireland’s major banks, were required to adopt IAS 39 for their annual accounting periods beginning on or after January 1, 2005. Under the “incurred loss” model of IAS 39, banks could set aside reserves for loan losses only when objective evidence existed that a loan was impaired, not in anticipation of future losses. As a result, Irish banks saw their aggregate reserve for bad loans drop from 1.2% of loan balances at the end of 2000 to only 0.4% by 2006-2007, just before the collapse of the banking industry caused loan losses to soar. In the aftermath of the global financial crisis, financial regulators and accounting bodies recognized the weakness of the pro-cyclical incurred loss model. As a result, they have proposed alternative “expected loss” models that allow reserves for expected losses to be built up over the life of a loan in a counter-cyclical fashion.

Keywords: Systemic Risk, Financial Crises, Financial Regulation

JEL Classification: G01, G28