Developments in the Credit Union Sector
FRS102 & Credit Unions
FRS102 has thrown a spanner in the works for Credit Unions particularly with regards to bad debt provisioning and writing off of non-performing loans.
Taking provisioning first, FRS 102 bans general provisions. I think what the authors were trying to achieve was to prohibit big bath accounting and in particular provisions for future events (which are specifically prohibited). What provisions are supposed to be are specific provisions for the actual impairment incurred at the date of the balance sheet.
What the PRA have done is to abandon the requirement to make a 2% general provision.
But a few minutes of reflection make it absolutely obvious that 35% of all loans 3 to 6 months in arrears is no less a general provision than 2% of all accounts from 0 to 3 months in arrears! There is a provision within the FRS for entities to make what is called an “Incurred but Not Reported (IBNR)” bad debt reserve. This is only for incurred impairment (not for future impairment) and is perhaps very similar to a general provision. What each entity is supposed to do is generate a calculation of risk based on past experience and provide accordingly. It would be a brave credit union which failed to act upon PRA requirements, and I would like to think that those required levels of provision are based on work that PRA have done looking at the sector in general.
Although not required by PRA I think that it is perfectly reasonable for credit unions to try to estimate the level of impairment in their loans less than 3 months in arrears and make an IBNR, which I am guessing will perhaps not be so far from the 2% previously required by PRA.
It has also always been the case that credit unions are able to provide more than the amounts required by the PRA. So if they can identify a loan which might be much less than one year in arrears but greatly impaired they should make additional provision. If the borrower is subject of an IVA a 100% provision would be appropriate, if made bankrupt the loan should be written off. I think all credit unions should make that additional provision or write-off based on the knowledge of the credit controller.
The second issue is that Section 11.33 of the FRS states that assets must be “derecognised (written off) only when the contractual rights to the cash flows from the financial asset are settled or expire”. Now many credit unions have written off Loans that are 12 months in arrears, although what the PRA require is 100% provision. Writing off is no longer permitted.
So Credit Unions can now only write off loans where its contractual rights have expired. The only situations in which this is clear cut are when the client is bankrupt, deceased without an estate, or when the statute of limitations kicks in after 6 years. I guess that a contractual right might be argued to expire if the borrower is known to be abroad and therefore out of the jurisdiction of the contract. I guess some credit unions will want to argue that it has expired if they can no longer find the person against whom they have contractual rights.
Credit Unions may not now write off loans more than 12 months old unless they have evidence that the contractual rights have expired.
With regard to loans already written off, directors should consider whether these should be written back (along with the 100% provision), but might want to consider whether the change in the balance sheet disclosure would be misleading, whether the information would be available and whether the cost of making the change would be disproportionate to any benefit.