IFRS and Basel 2

IFRS and Basel 2
Ian Michael
Accounting and Auditing Policy Department
Financial Services Authority
Contact: [email protected]
IFRS and Basel 2: Key themes
Widespread adoption of IFRS
Interaction of IFRS with existing regulatory rules
Interaction of IFRS with Basel 2
Disclosure requirements
Widespread adoption of IFRS
• IFRS increasingly becoming global standards
• Adoption in EU from 2005 (mandatory for group
accounts of listed companies)
• Now used in nearly 100 countries
EU Experience
• Adoption of IFRS appears to have gone quite smoothly,
even though differences from national GAAPs often
Typical differences between IFRS and national
GAAPs relevant to financial sector
Valuation – especially use of fair values
Classification of financial instruments
Hedge accounting
Interaction of IFRS with existing regulatory rules
• Definition of regulatory capital
• ‘Prudential filters’
Definition of regulatory capital
• IFRS (IAS 32) will sometimes indicate a different split
between equity and liabilities than national GAAP
• However, definition of regulatory capital driven to a
considerable extent by the Basel Accord
• Note that regulatory capital includes some elements which
are unquestionably accounting liabilities, eg subordinated
• However, impact of IFRS on measured equity is the key
reason for prudential filters
Prudential filters (1)
• Cash flow hedges. Under IAS 39, cumulative fair value
gains/losses on hedging instruments are recognised
directly in equity, to the extent hedges are effective
But such gains/losses excluded from regulatory capital
• Application of fair value option to an institution’s
liabilities. Gains/losses arising from changes in an
institution’s own credit risk are excluded from regulatory
Prudential filters (2)
• Available – for – sale instruments
– loans
– debt securities
– equities
• Own – use and investment properties
Two important areas of difference between
prudential and accounting treatments
• Securitisations
• Netting
The Fair Value Option (FVO)
No prudential filter, but…
Supervisory Guidance on use of FVO by banks
Guidelines and recommended practices address:
(a) Sound risk management and control processes for
banks that utilise the FVO;
(b) Supervisory consideration of banks’ use of the FVO
in the context of evaluating the adequacy of risk
management and regulatory capital
Approach to FVO needs to be set in context of a
supervisor’s overall strategy towards an institution
Interaction of IFRS with Basel 2
• Most significant issue is the relationship between
accounting loan loss provisions, which under IAS 39 are
based on an incurred loss model, and the Basel 2 concept
of expected loss
• This is discussed in draft Basel paper on ‘Sound credit
risk assessment and valuation for loans’
• Commonality of methodologies and data for credit risk
assessment, accounting and capital adequacy purposes
• Nonetheless, accounting and Basel 2 numbers may differ
Disclosure requirements
• Enhanced transparency and its contribution to market
discipline has been a major theme in prudential
regulation, and accounting, in recent years
• Prudential response: Pillar 3 of Basel 2
• Accounting response: IFRS 7 – Financial Instruments
Relationship between Pillar 3 and IFRS 7
• May have different scope
• Audit assurance probably higher for IFRS disclosures
• Pillar 3 emphasises credit risk model embedded within
Basel 2, and in some other respects is more prescriptive
• So Pillar 3 and IFRS are complementary