4.2 Management of Risk: General Remarks 87IFRS. Accounting for loan relationships is important not only for lenders but
also for debtors. Accounting standards set out when lenders may record loan as-
sets at market value and when they must write down the asset. If the asset is writ-
ten down, the lender will incur a loss. This will signal poor credit quality to other
existing or potential lenders and, as the lender already has incurred a loss, make
the lender less friendly.
Accounting for loans can fall within the scope of IFRS (IAS 39). Initially, financial assets
and liabilities should be measured at fair value (including transaction costs, for assets and
liabilities not measured at fair value through profit or loss). Subsequently, financial assets
and liabilities should be measured at fair value. There are some exceptions. For example,
loans and receivables, held-to-maturity investments, and non-derivative financial liabilities
should be measured at amortised cost using the effective interest method (IAS 39.46). This
means that IAS 39 recognises two classes of financial liabilities: financial liabilities at fair
value through profit or loss; and other financial liabilities measured at amortised cost (IAS
39.47). The entity can use a fair value option subject to certain conditions (IAS 39.9).
Accounting for loan loss can contain judgmental areas. The most judgmental area in
loan loss allowance determination is when to establish that a loss has been incurred and
how to estimate these losses, before the loss event has become specifically identifiable.
According to IFRS, a financial asset is impaired, and impairment losses are recognised,
only if there is objective evidence as a result of one or more events that occurred after the
initial recognition of the asset (IAS 39.58). Under IFRS, allowances can thus be established
for objectively verifiable incurred loss events. In the amendments of IAS 39, the IASB has
concluded that it is possible to accept loan loss allowances for incurred but not yet identi-
fied loan loss.
There can be differences in the application of US GAAP and IFRS with respect to de-
termining loan loss allowances. In practice, however, the principles regarding the account-
ing for loan loss allowances under US GAAP and IFRS are essentially converged and the
allowance for loan losses should, in principle, be the same.
4.2 Management of Risk: General Remarks
The borrower will manage the risk exposure of lenders. For example, factors
that signal a lower risk to lenders might include: a long history without defaults
(this can signal that the borrower knows how to avoid credit default even in the
future); unrestricted assignability (making exit easier); a large and diversified
investor base (this can signal that the debt securities are liquid, that their market
valuation is reliable, that there is easier exit, and that the risk of market collapse
is lower); a dense distribution of maturities (this can signal that the borrower will
be able to pay when securities fall due); and the existence of credit enhancements
(Volume II).
The borrower will also manage its own risk exposure. For the borrower, loan
facility agreements can give rise to the same risks as contracts (see Volume II) or
funding contracts (section 2.4) in general. In addition, some risks are characteristic
of loan facility agreements in particular.