A new rule approved in February by the Financial Accounting Standards Board (FASB) could have wide-ranging consequences for banks, from the branch right down to the balance sheet.

FASB’s new rule would require all businesses and nonprofits to book all long-term leases (anything over 12 months) as both assets and liabilities on their balance sheets. Right now, many companies disclose those leases in the footnotes to their financial statements, and unless they’re lease-to-own transactions, they typically aren’t recorded as liabilities.

For financial institutions, which not only lease property but also lend money to businesses that lease property, the implications are numerous.

“It really affects all industries,” Giuseppe “Joe” Femia, vice president and director at the accounting firm G.T. Reilly & Co., said of the rule. “But with banks and credit unions, it’s going to affect them if they have branches. If they lease branch locations, they’re going to have to record an asset and a liability, which could potentially hurt their capital ratios.”

That rule is anticipated to have an outsized effect on financial institutions that have a large branch network, particularly those that lease, rather than own, many of their locations.

Donald J. Musso, president and CEO of the New Jersey-based consulting firm FinPro, said the rule could effectively eliminate long-term leasing and, naturally, a business that leases a property for just three years isn’t going to get the same rate as a business that might lease that property for 10 years.

“It’s more than just the balance sheet. We’re going to have to book these leases and hold them on the balance sheet. More importantly, we’re going to have to book capital against that,” he said. “All of a sudden, leasing isn’t the advantage it was two years ago.”

And Femia said the rule could also impact banks as lenders, not strictly as lessees. Commercial borrowers who lease property will now have to record those leases on their balance sheets. That, in turn, will have an impact on their debt ratio, and if banks’ loan covenants with those borrowers include any provision related to the borrower’s debt ratio, that could complicate things.

“It sort of grosses up the balance sheet, which hurts the capital ratio and debt ratio,” Femia said. “It hurts your capital ratio when you’re a financial institution and your debt ratio when you’re a commercial borrower. It’s basically like bringing debt onto the books.”

Musso had harsher words, however, arguing that the rule would make sense, at least, if FASB had applied it to all types of long-term contracts and not strictly real estate leases. He still wouldn’t like it, he said, but it would make sense.

Alluding to FASB’s current expected credit losses model, yet another headache for bankers, he said, “You’ve really got to wonder what’s motivating FASB in the financial sector.”

Taking A Proactive Approach

The rule won’t take effect until 2020, but experts say financial institutions need to be proactive in how they approach it.

“The big story for banks is [to] analyze the impact this may have bank and plan accordingly,” Musso said. “Don’t wake up and be reactive. We need to proactively analyze it and figure out how we’re going to address it.”

When working with commercial borrowers, Femia suggested that perhaps banks might exclude the commercial borrower’s capital lease obligations from their debt ratios.

And the lease accounting rule will undoubtedly have an impact on banks’ decisions concerning their branch networks. Experts say the rule will pique questions about whether it’s better to buy or lease – or whether it’s worth it to expand your branch network at all.

“Let’s say, for example, a bank is thinking of opening a new branch. If it’s really in a prime location they know they’re going to be in forever, they may be better off buying the building instead of leasing it. That way you get an asset on your books instead of a liability,” Femia said. “But that’s for the long haul, so if it’s an area you’re not sure about, that doesn’t make sense because then you’re stuck with a building you can’t do anything with afterwards.”

Musso also thinks the new FASB rule will only accelerate the current trend of the shrinking branch network.

“I do think it’s going to force people to look at their networks, and it is going to force continued change in the way we deliver our products and services to customers,” he said. “We’ve been telling people that the delivery network of the future is going to be digital, people and a limited-branch network and I think this is going to accelerate and exacerbate it.”

Editor’s Note: This article was updated on May 10 to clarify that banks may want to exclude commercial borrowers’ capital lease obligations from their debt ratios.