Before we get stuck into the detail, let's think about how credit losses are accounted for in the financial statements.

When a bank makes a loan, there is a risk that the borrower doesn't repay the money that is owed.

From an accounting perspective, if a bank has any loss on a loan, this needs to be reflected in their financial statements by reducing the value of the loan asset in the balance sheet and showing an equivalent expense, a loss in the income statement, reducing its profits.

However, the rules around when an expense needs to be recognized in the income statement and a loss provision set up in the balance sheet are not straightforward.

Before we get into the current rules, let's start by thinking about the previous set of rules that applied to credit losses.

Here. Provisions for credit losses were measured in accordance with what was known as an incurred loss model.

Losses were only recognized once they'd actually been an incurred loss event.

In fact, entities were prohibited from taking account of expectations of future credit losses.

However, banks were able to estimate the level of losses that had been incurred, but had not yet been reported to the bank.

And this made the whole thing pretty complex and convoluted since a range of different impairment models applied to financial assets, debt instruments, and equity.

In addition, the global financial crisis of 2008 exposed significant weaknesses in these rules by making banks' financial statements look healthier than they actually were.

The current accounting rules have a totally different focus, both the IFRS and US Gap Accounting rules, both now use a forward-looking expected credit loss model.

This has resulted in credit losses being recognized earlier as banks and other financial companies no longer have to wait for an incurred loss event.

This means that losses that might be expected to happen in the future have already been accounted for within the bank's financial statements.

There are some technical differences between the IFRS and US accounting rules in terms of how expected credit losses are accounted for, which we'll look at in more detail.