The Measurement and Disclosure of Impaired Debts, Credit Risk and Credit Loss Allowance

At the end of 2007 the Supervisor of Banks issued a directive on the measurement and disclosure of impaired debts, credit risk and credit loss allowance (“the Directive”). The Directive brought the Guidelines for Preparing Reports to the Public applicable to banking corporations and credit card companies in Israel into line with the regulations applicable to the banking system in the US and in other major economies. The Directive went into effect on January 1, 2011, and it will be reflected in the notes to the banks’ 2010 financial statements that will be published at the end of this month.

The Directive adopts more structured and detailed standards for the measurement and disclosure of credit risks in banking corporations’ financial statements. These are intended to:

enable comparisons to be made of banks in Israel with each other and with banks abroad;

enhance the ability of banking corporations to monitor and manage credit risks by, among other things, increasing the uniformity and consistency of the measurement of expected credit losses, in light of the closer relation it creates between changes in the quality of credit and changes in the credit loss allowance;

Improve the ability to calculate future credit loss allowances by means of a mechanism of group allowances for debts with similar characteristics.
The Bank Supervision Department followed the banking corporations’ preparations to implement the Directive, and received the original estimates that the banking corporations had to prepare concerning the effect of the Directive on the financial data. Based on the estimates to September 30, 2010, the following trends were noted with regard to the effect of the Directive on the financial data of the banking system:

The cumulative total write-offs and allowances for credit losses in the whole of the banking system are expected to increase by up to 5 percent as a result of the initial implementation of the Directive. This will have the effect of reducing the cumulative equity of the entire banking system by up to 5 percent.

A certain reduction in the total balance of criticized commercial debts (criticized debts not of individuals) is expected, and at the same time the share of the most problematic commercial debts (the balance of impaired debts) in total commercial credit to the public is expected to grow. The share of those debts in the whole banking system (correct to September 30, 2010, the share was 3.7 percent) is expected to increase by up to 200 basis points. All the above is after deducting write-offs and specific allowances for credit loss.

The point must be stressed that despite the implications of the Directive for the financial data of any individual banking corporation, the implementation of the Directive is not expected to impact on the extent of the banking system’s ability to meet the requirements of the Supervisor of Banks, including the capital adequacy requirements.