1 IFRS in the Banking Sector A supervisor’s perspective REPARIS Workshop Marc Pickeur Vienna CBFA March 2006 Belgium

2 Objective Introduction of IAS/IFRS: what have been the actions of supervisors? Overview of actions undertaken by  Basel Committee (BCBS)  European Supervisors (CEBS)

3 Overview Basel Committee on Banking Supervision  2000: Basel Committee’s review of IAS  2005: Supervisory guidance on the use of the fair value option by banks (ED)  2005: Sound credit risk assessment and valuation for loans (ED) Committee of European Banking Supervisors  FINREP  COREP

4 Basel Committee on Banking Supervision April 2000: Report to the G7 Finance Ministers and Central Bank Governors  Interest of banking supervisors  Issues of supervisory concern  …

5 Basel Committee on Banking Supervision Accounting standards should contribute, or at least be consistent, with sound risk management and control practices in banks Accounting standards should facilitate market discipline Accounting standards should facilitate and not constrain the effective supervision of banks

6 Basel Committee on Banking Supervision IAS 39 may have a major impact on how banks account for financial risks that are hedged; It would be of concern to the Committee if the restrictive nature of the hedging provisions of IAS 39 encouraged banks to move away from meeting the principles for best practice global risk management;

7 Basel Committee on Banking Supervision Fair value measurement in the absence of active markets: difficulties in obtaining or calculating reliable fair values for certain non-marketable financial instruments. The Committee does not believe that the time is right to prescribe full fair value accounting in the primary financial statements for all financial instruments.

8 Overview Basel Committee on Banking Supervision  2000: Basel Committee review of IAS  2005: Supervisory guidance on the use of the fair value option by banks (ED)  2005: Sound credit risk assessment and valuation for loans (ED) Committee of European Banking Supervisors  FINREP  COREP

9 Basel Committee on Banking Supervision July 2005: Supervisory guidance on the use of the fair value option by banks (ED)  The purpose of the option was to simplify the application of IAS 39, which imposes a mixed- attribute measurement model on financial instruments;  This document is not intended to set forth additional accounting requirements beyond those established by the IASB.

10 BCBS Fair value option: Basis for conclusions Supervisors’ objective is maintaining financial soundness of individual banks and the financial system. Recognition of role of supervisors in an accounting standard.

11 Basel Committee on Banking Supervision Fair value option: Main actions Banks should implement strong risk management and controls: the effect of the use of the fair value option should be understood, managed, monitored and reported in a sound manner. Unrealised gains or losses on items designated as at fair value should not alter regulatory capital in a way that would be unsound.

12 Basel Committee on Banking Supervision Supervisory expectations relevant to the use of the fair value option 1. Supervisors expect a bank’s application of the fair value option to meet the criteria set forth in IAS 39 in form and in substance. 2. Supervisors expect banks to have in place appropriate risk management systems (including related risk management policies, procedures and controls) prior to initial application of the fair value option for a particular activity or purpose and on an ongoing basis. 3. Supervisors expect banks to apply the fair value option only to instruments for which fair values can be reliably estimated. 4. Supervisors may require banks to provide supplemental information to assist them in assessing the impact of banks’ utilisation of the fair value option.

13 Basel Committee on Banking Supervision Supervisory assessment of risk management, controls and capital adequacy 5. Supervisors should assess whether a bank’s internal financial analysis of counterparties evaluates the impact of the counterparties’ use of the fair value option. 6. Supervisors should evaluate a bank’s risk management and control practices as they pertain to the use of the fair value option. 7. Supervisors should consider risk management and control practices related to the use of the fair value option when assessing capital adequacy. 8. Regulatory capital should be adjusted for gains and losses from changes in own credit risk as a result of applying the fair value option to financial liabilities.

14 Overview Basel Committee on Banking Supervision  2000: Basel Committee review of IAS  2005: Supervisory guidance on the use of the fair value option by banks (ED)  2005: Sound credit risk assessment and valuation for loans (ED) Committee of European Banking Supervisors  FINREP  COREP

15 Basel Committee on Banking Supervision November 2005: Sound credit risk assessment and valuation for loans (ED)  Provides banks and supervisors with guidance on sound credit risk assessment and valuation policies and practices.  Addresses how common data and processes may be used for credit risk assessment, accounting and capital adequacy purposes.  Highlights provisioning concepts that are consistent in prudential and accounting frameworks;  Focuses on policies and practices that will promote sound credit risk assessment and controls.

16 Basel Committee on Banking Supervision Supervisory expectations concerning sound credit risk assessment and valuation for loans 1. The bank’s board of directors and senior management are responsible for ensuring that the banks have appropriate credit risk assessment processes and effective internal controls to consistently determine provisions for loan losses in accordance with the bank’s stated policies and procedures, the applicable accounting framework and supervisory guidance commensurate with the size, nature and complexity of the bank’s lending operations. 2. Banks should have a system in place to reliably classify loans on the basis of credit risk. 3. A bank’s policies should appropriately address validation of any internal credit risk assessment models.

17 Basel Committee on Banking Supervision 4. A bank should adopt and document a sound loan loss methodology, which addresses credit risk assessment policies, procedures and controls for assessing credit risk, identifying problem loans and determining loan provisions in a timely manner 5. A bank’s aggregate amount of individual and collectively assessed loan provisions should be adequate to absorb estimated credit losses in the loan portfolio. 6. A bank’s use of experienced credit judgement and reasonable estimates are an essential part of the recognition and measurement of loan losses. 7. A bank’s credit risk assessment process for loans should provide the bank with the necessary tools, procedures and observable data to use for credit risk assessment purposes, account for impairment of loans and the determination of regulatory capital requirements.

18 Basel Committee on Banking Supervision Supervisory evaluation of credit risk assessment for loans, controls and capital adequacy 8. Banking supervisors should periodically evaluate the effectiveness of a bank’s credit risk policies and practices for assessing loan quality. 9. Banking supervisors should be satisfied that the methods employed by a bank to calculate loan loss provisions produce a reasonable and prudent measurement of estimated credit losses in the loan portfolio that are recognized in a timely manner. 10. Banking supervisors should consider credit risk assessment and valuation policies and practices when assessing a bank’s capital adequacy.

19 Overview Basel Committee on Banking Supervision  2000: Basel Committee review of IAS  2005: Supervisory guidance on the use of the fair value option by banks (ED)  2005: Sound credit risk assessment and valuation for loans (ED) Committee of European Banking Supervisors  FINREP  COREP

20 CEBS Developed two reporting frameworks: FINREP: Financial reporting COREP: Solvency reporting

21 CEBS CEBS GUIDELINES ON FINANCIAL REPORTING (FINREP – Published )  A standardised financial reporting framework for credit institutions operating in the EU.  FINREP will enable credit institutions to use the same standardised data formats and data definitions for prudential reporting in all countries where the framework will be applied.  FINREP will reduce the reporting burden for credit institutions that operate cross-border, and lower barriers to the development of an efficient internal market in financial services.

22 CEBS CEBS GUIDELINES ON COMMON SOLVENCY REPORTING (COREP – Published ) To be used by credit institutions and investment firms when they report their solvency ratio to supervisory authorities under the Capital Requirements Directive.

23 CEBS Expert Group on Financial Information  Subgroup Reporting update FINREP and COREP answer questions from users about FINREP & COREP update XBRL taxonomies / monitor XBRL developments

24 REPARIS WORKSHOP