The Basel Committee on Banking Supervision has released a set of high level principles to assist the International Accounting Standards Board (IASB) in replacing International Accounting Standard (IAS) 39, which is related to fair value measurement. The IASB is currently endeavouring to develop new global accounting standards to improve the decision usefulness and relevance of financial reporting for key stakeholders, including prudential regulators.
According to the banking supervisory forum, the principles are aimed at ensuring that accounting reforms address broader concerns about procyclicality and systemic risk. Nout Wellink, chairman of the Basel Committee and president of the Netherlands Bank, explains: “In developing the high level principles, the Basel Committee closely examined the lessons learned from the financial crisis. One of those lessons is that any new accounting rules must be consistent with sound practices in risk management and enhance transparency to help supervisors, banks, investors and other stakeholders achieve their respective objectives.”
The principles are therefore a response to recommendations made by the G20 leaders at their April 2009 summit to strengthen financial supervision and regulation. The G20 leaders asked global accounting standard setters to work urgently with supervisors and regulators to improve standards on valuation and provisioning and achieve a single set of high quality global accounting standards.
The IASB published its set of proposals for an overhaul of these standards in July, following months of collaboration with the Financial Accounting Standards Board (FASB) to eradicate the differences between the applications of accounting rules on both sides of the Atlantic. They included proposals that dealt with concerns raised by market participants such as eliminating the different impairment approaches for available for sale assets and assets measured using amortised cost.
The Basel Committee has added its own set of principles to the mix to facilitate continued, necessary coordination among standard setters, supervisors and regulators in their respective efforts to implement the G20 recommendations. It says that the principles reflect accounting lessons learned from the financial crisis, such as recommendations for accounting standards to reflect the need for earlier recognition of loan losses to ensure robust provisions. It also indicates that standards setters must recognise that fair value is not effective when markets become dislocated or are illiquid. This means that they must therefore permit reclassifications from the fair value to the amortised cost category, which should be allowed in rare circumstances following the occurrence of events having clearly led to a change in the business model. Overall, the aim of the principles is to promote a level playing field across jurisdictions.
To address particular concerns about procyclicality, the Committee indicates that new standards should provide for valuation adjustments to avoid misstatement of both initial and subsequent profit and loss recognition when there is significant valuation uncertainty. Moreover, loan loss provisions should be robust and based on sound methodologies that reflect expected credit losses in the banks’ existing loan portfolio over the life of the portfolio, it continues.
The focus is on improving “relevance” and “usefulness” of accounting standards to the market and not in expanding fair value to more instruments than before, cautions the Basel Committee. Much like most of the other recent regulatory recommendations, the focus is on improving perceptions and practices around risk management. As such, these principles should add yet more fuel to the fire for valuations vendors in terms of providing transparency and more data in the pricing space. It should also lend to the cause of the chief risk officer (CRO) in endeavouring to get a better handle on a firm’s financial position.