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Current Approaches to the Establishment of Credit Risk Specific Provisions

Author

Listed:
  • Ion Nitu

    (Academy of Economic Studies, Bucharest)

  • Alin Eduard Nitu

    (Academy of Economic Studies, Bucharest)

  • Eliza Paicu

    (Academy of Economic Studies, Bucharest)

Abstract

The aim of the new Basel II and IFRS approaches is to make the operations of financial institutions more transparent and thus to create a better basis for the market participants and supervisory authorities to acquire information and make decisions. In the banking sector, a continuous debate is being led, related to the similarities and differences between IFRS approach on loan loss provisions and Basel II approach on calculating the capital requirements, judging against the classical method regarding loan provisions, currently used by the Romanian banks following the Central Bank’s regulations. Banks must take into consideration that IFRS and Basel II objectives are fundamentally different. While IFRS aims to ensure that the financial papers reflect adequately the losses recorded at each balance sheet date, the Basel II objective is to ensure that the bank has enough provisions or capital in order to face expected losses in the next 12 months and eventual unexpected losses. Consequently, there are clear differences between the objectives of the two models. Basel II works on statistical modeling of expected losses while IFRS, although allowing statistical models, requires a trigger event to have occurred before they can be used. IAS 39 specifically states that losses that are expected as a result of future events, no matter how likely, are not recognized. This is a clear and fundamental area of difference between the two frameworks.

Suggested Citation

  • Ion Nitu & Alin Eduard Nitu & Eliza Paicu, 2008. "Current Approaches to the Establishment of Credit Risk Specific Provisions," Theoretical and Applied Economics, Asociatia Generala a Economistilor din Romania / Editura Economica, vol. 10(10(527)), pages 71-86, October.
  • Handle: RePEc:agr:journl:v:10(527):y:2008:i:10(527):p:71-86
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