The Financial Accounting Standard Board (FASB) recently released a new lease accounting standard, which took effect for public firms on January 1, 2020, and will take effect for private firms on January 1, 2021.
The new lease accounting standard will require companies to record operating leases as both liabilities and assets on their balance sheets to give a more complete picture of a company’s financial obligations.
This change may have significant impacts for banks, in regard to:
- Loan Covenants
Loan covenants often place limits on overall debt, or require customers to maintain certain debt ratios. By eliminating off-balance-sheet treatment for most operating leases, banks may see an increase in inflated balance sheets among their customers. With this increase in assets and liabilities, some loan customers may find themselves in violation of their loan covenants.
- Capital Ratio
Similarly, banks with substantial operating leases for facilities, equipment and other fixed assets may see an inflation in their own balance sheets. This could potentially reduce capital ratio, a measurement which is used to determine capital adequacy.
Banks should review existing customer loan covenants to evaluate the impact of the new standard and consider revising existing and future loan covenants to avoid unnecessary breaches. They should also assess the impact of the new standard on their own balance sheets, to plan for any changes in capital levels.
Do you have questions about the new lease accounting standard? Leave a comment below, or feel free to contact me directly, I’m happy to help.