September 1, 2009
To the International Accounting Standards BoardJapanese Bankers Association

Comments on Request for Information (‘Expected Loss Model’)Impairment of Financial Assets: Expected Cash Flow Approach

The Japanese Bankers Association (JBA) is an organization whose members
consist of banks and bank holding companies that operate in Japan. The JBA acts
as the representative of the Japanese banking industry.
We, as an association, have compiled the following comments regarding theExpected Loss Model that is currently being deliberated by the International
Accounting Standards Board (IASB), and we ask that you kindly review them.
It is our hope that the following comments will assist in the remaining work of
the IASB in the deliberation of this subject.

Question 1
Is the approach defined clearly? If not, what additional guidance is needed, andwhy?
1. Although the basic concept of the approach is understood clearly, we do notbelieve the details of the calculation methods, including the estimation methods ofexpected cash flows, are defined clearly. For example, in the IASB’s proposals,
examples are given based on the assumption that the actual amount of all cash
flows can be forecasted, and given that assumption, default rate per annum is used
to estimate the future cash flows. However, it is not stated clearly how to define andcalculate the default rate per annum in practical viewpoint.
In order to ensure objectivity and comparability of financial statements,
sufficient guidelines on the estimation method of expected cash flows should beprovided, including the following items.
(1)

In the IASB’s proposals, while calculations of the default rate per annum

are required, the default rate per annum comprises probability of default (PD)and loss given default (LGD). In calculating PD, we need to determine thedefinition of default. We think that it would be acceptable as long as PD isdefined in a way consistent with LGD.
1(2)Since collaterals are provided for loans in many cases, collection fromcollaterals should be considered in determining LGD.
Furthermore, as we stated in an answer for the Question 2, the burden to apply
this approach in practice will be extremely heavy. We strongly request that theguidelines including detailed numerical examples be provided to simplifyprocedures on the basis of sufficient cost-benefit analysis. As for numericalexamples, it is desirable that a lot of alternative methods areprovided to theextent available.
Moreover, in view of consistency and costs, it should be allowed that banks
adopting Basel II can use the same data as used for the purpose of BaselⅡ.

Question 2
Is the approach operational (i.e. capable of being applied without undue cost)?
Why or why not? If not, how would you make it operational?
2.

The approach is not operational, because it requires a great burden both interms of systems and administrative procedures. In order to apply the expected loss
model, future projections would be required, and they should be based on historical
data that have been accumulated over a certain period of time. However, it isunlikely that all companies which should adopt this approach have currently
accumulated the necessary data. The banks adopting Basel Ⅱ do not necessarily
have sufficient data for expected loss model. ( They only have PD and LGD for thepurpose of Basel Ⅱ.)
3.

Japanese banks generally manage loans on a borrower-by-borrower basis,

rather than loan-by-loan basis. In order to apply the proposed approach to eachborrower, a completely new system needs to be developed solely for purpose ofadopting this approach separately from the contract management system forcustomer transactions. The system for expected loss model can not be used for otherpurposes, because expected loss model does not mean that the right to make claims
to customers will legally expire. In addition, development of an interface between
the system for expected loss model and the contract management system will also
be required.

Question 3
What magnitude of costs would you incur to apply this approach, both for initial2implementation and on an ongoing basis? What is the likely extent of system andother procedural changes that would be required to implement the approach as
specified? If proposals are made, what is the required lead time to implement suchan approach?
4.

At present, it is impossible to estimate the actual costs for initial

implementation and maintenance, as well as the lead time. However, we do forecast
that we will incur significant costs and need a considerably long time.
5.

Considering the following aspects, we believe that it is highly possible that theburden for its implementation will greatly exceed the burden for implementing
Basel II.
(1) In general, Japanese banks manage book value of loans based on theoutstanding balance of contractual principals. Currently, we are not using theamortized cost method set forth by the International Financial ReportingStandards (IFRS). Thus, it is likely that the burden for implementation will beconsiderably greater for us, compared with European banks that have already
implemented the amortized cost method based on the current IFRS.
(2) We would need to develop a system for estimating expected cash flows, inaddition to the system for recognizing interest revenue based on effective
interest rate. It means that we would have to develop both the accounting
system and the management information system on a large scale, which would
make our burden inordinately large. We forecast that we would need at least 5years to develop these systems.
(3) In order to estimate expected cash flows, we would be required to develop
our own expected loss model based upon our internal estimations. Even thebanks adopting Basel II will not be able to rely only on PD and LGD parametersfor Basel II. Therefore, development of new calculation methods is required,based on data accumulation of parameters and available data.
(4) Since the fundamental logic for the balance sheets and the income
statements will be changed, the effects will spread widely, including change ofworkflow at operating offices, review of management accounting and change ofrisk management methods, etc.

Question 4
How would you apply the approach to variable rate instruments, and why?
6.

There are multiple methods indicated for calculating variable rates. However,3

deciding which one to use should be left to the discretion of the preparer of financialstatements.

Question 5
How would you apply the approach if a portfolio of financial assets waspreviously assessed for impairment on a collective basis and subsequently a loss isidentified on specific assets within that portfolio? In particular, do you believe:(a) changing from a collective to an individual assessment should be required?
If so, why and how would you effect that change?
(b) a collective approach should continue to be used for those assets (for which
losses have been identified)? Why or why not?
7.

Whether to individually manage loans whose credit standings have worsened

should be decided based on the perspective of risk management and the regulatory
requirements of the financial administrations of each country.
8.

If the credit standing of a borrower whose loans were being collectively assessed

becomes worse, we suppose that these loans would be managed individually. In thatcase, we think that these loans should be individually estimated when reviewing
the expected cash flows at each period. Therefore, even if the collective approach iscontinued, expected cash flows of these loans would probably need to be calculated
separately and then totaled again.

Question 6
What simplifications to the approach should be considered to address
implementation issues? What issues would your suggested simplifications address,and how would they be consistent with, or approximate to, the expected cash flow
model as described?
9.

In terms of accounting for impairment loss, discussions need to be made notonly regarding the simplification of expected cash flow approach, but also regarding
improving the Incurred Loss Model under current IAS 39. For example, we might beable to find an alternative approach to addressing the failings of current incurred
loss model by modifying the current model to reflect not only the past statistical
data but also future data into the estimated allowances and thus incorporate
forward looking viewpoint into the provision for loan losses.

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