By Yali N’Diaye

WASHINGTON (MNI) – An accounting rule that has yet to be adopted
has the potential to boost U.S. large banks assets by an average 68%,
and liabilities by nearly 72%, Standard & Poor’s said Wednesday.

The International Accounting Standards Board (IASB) and its U.S.
counterpart, the Financial Accounting Standards Board (FASB), have been
struggling to converge their approaches to offsetting financial assets
and liabilities.

And if convergence is not achieved, which Standard & Poor’s deems
“the likely final outcome” in a report titled “Accounting Proposal
Struggles To Create Global Convergence In Balance Sheet Offsetting,” the
differences between global accounting regimes will be “significant.”

And in this case, U.S. banks will mostly feel the impact relative
to their European counterparts.

The FASB put out an exposure draft in January 2011 on Balance Sheet
Offsetting that provides guidance on when companies can offset financial
assets and liabilities.

Also in January, the IASB put out an equivalent proposal called
“Offsetting Financial Assets and Financial Liabilities.”

Of particular importance both to large banks and their regulators
is the issue of netting derivatives subject to so-called ‘master netting
agreements,’ which are standardized contracts defining rights such as
netting, in relation to one or more derivatives contracts or repurchase
and swap agreements.

If the FASB proposal is “finalized in its current form, U.S.
companies would not be allowed to offset as many financial assets and
liabilities (particularly derivatives) as now permitted,” Standard &
Poor’s said. “This will result in larger balance sheets, particularly
for large, complex financial institutions.”

And that at a time U.S. regulators are trying to address the issue
of too-big-to fail.

Under the current U.S. accounting regime, companies can only net
financial assets and liabilities if the counterparty is the same and
there is a legally enforceable right to offset.

However, exceptions are granted for derivatives under a single
master netting agreement under certain conditions.

The proposed U.S. standards, however, eliminate exceptions for
derivatives under a master netting agreement. “Simply put, it would
gross up U.S. balance sheets,” S&P said.

Under the international financial reporting standards (IFRS), there
are no exceptions, either in the current or the proposed standards,
which is why the impact for companies already using IFRS would be less
than for U.S. financial institutions, many of which use the option to
apply the netting.

Based on a sample of large U.S., Standard & Poor’s estimated that
assets would increase by an average 68.4%, ranging from a 31.4% increase
for Citigroup to +104.7% for Morgan Stanley as a result of grossing up
derivatives assets and liabilities.

The increase in liabilities would be an average 71.7% for the large
U.S. banks.

“We estimate the potential average increase for the U.S. financial
institutions in derivative assets and derivative liabilities would by
approximately $961 billion and $935 billion, respectively, under the
proposed standard,” the report said.

On the other hand, “We do not expect the impact of the proposed
standard to be significant for European financial institutions, because
the differences between IFRS and the proposed standard are minimal,” the
report added.

The rating agency urged convergence of the standards, but warned
that reporting derivatives on a gross basis “may obscure the company’s
financial risks.”

Standard & Poor’s also noted that banking regulators have yet to
decide about their own treatment of derivatives.

For instance, “gross presentation under the proposed standard would
weaken the leverage ratio currently used by U.S. banking regulators.
Consequently, if the standard is finalized in its current form, the new
rules could cause regulators to modify their minimum leverage ratios.”

“Alternatively, regulators may decide to exclude derivatives
subject to master netting agreements for regulatory capital purposes
altogether,” the report continued. “If the regulators decide to simply
retain the current rules, potentially resulting in banks holding greater
amounts of capital, we believe it would be viewed most unfavorably by
the banks.”

Especially as large banks are now facing a growing reality of not
being rescued in case of failure, which triggered Moody’s to downgrade
some of them Wednesday.

The report also suggested that the impact of adopting new rules on
banks’ balance sheets could translate into higher premiums charged by
the Federal Deposit insurance Corporation, which changed the assessment
base to assets from liabilities earlier this year.

It remains to be seen how the FDIC would adjust, if at all, should
FASB’s new standards be implemented and banks’ assets increased as a
result.

** Market News International Washington Bureau: 202-371-2121 **

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