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REPARIS

Analyzing disclosures: IFRS 7 and capital

requirements disclosures

Shamim Diouman REPARIS IFRS Seminar for banking supervisors

Croatia National Bank, Zagreb – April 18-19, 2012

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Section 1: IFRS 7 Disclosures

Overview IFRS 7

Recent amendments

IAS 1 Disclosure requirements

Why analyse disclosure requirements?

Disclosure requirements credit risk

Disclosure requirements market risk

Examples Credit risk and market risk disclosures

Section 2: Analysing Disclosures: Prudential Filters

Objectives of prudential filters

List of prudential filters

Disclosures of prudential filters

Section 3: IFRS 7 and capital disclosures developments

IFRS 7 developments

Capital disclosures developments

Outline

The objectives are to update participants of the key issues on:

IFRS 7 disclosures

Prudential filters and their related disclosures

Capital requirements disclosures

The session is divided into three sections

The three sections are related and international regulators are

currently focussing on them

Each section is highly topical and important as closely related

to prudential capital

Objectives of the session

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Section 1 covers IFRS 7 Disclosures and focuses mainly on

market and credit risk

This section includes an overview of IFRS 7 and practical

examples of disclosures

Other points included are:

Why is IFRS 7 relevant for regulators?

Why should regulators review the disclosures?

Can the disclosures provide an early warning system to

the next financial crisis?

Section 1: IFRS 7 Disclosures

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Section 1 ‒ IFRS 7 disclosures

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IFRS 7: Disclosures about financial instruments

IFRS 7 issued in 2005 and replaced IAS 30 and IAS 32

The IFRS 7 disclosure requirements incorporate many

of the requirements of IAS 32

There are exceptions: such as pensions, insurance

contracts, etc.

Applicable to all entities even if they have only a few

financial instruments

But the extent of disclosure required depends on their

use of financial instruments and exposure to risk

Overview – IFRS 7

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Qualitative and quantitative disclosures i.e. words and

numbers

The IASB believes that users of financial statements

need information about an entity‟s exposure to risks and

how those risks are managed

Disclosures in IFRS 7 are around 3 main areas: Credit

risk, market risk and liquidity risk

Overview – IFRS 7

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A number of amendments made to IFRS 7 pre and post

crisis

Some amendments related to changes to IAS 39 and

firms‟ management of exposures to risk keeps evolving

March 2009 – enhanced disclosures about fair value

measurements and liquidity risk

October 2010 – transfers of financial assets – to help

users of financial statements evaluate the risk exposures

relating to transfers of financial assets and the effect of

those risks on an entity‟s financial position

Recent amendments to IFRS 7

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IAS 1 also include a number of key disclosure

requirements:

Summary of significant accounting policies

Measurement basis

Accounting policies used that are relevant to an understanding of

the financial statements

The disclosure requirements in IAS 1 are directly related

to the disclosure requirements in IFRS 7

IAS 1 Disclosure requirements

Regulators have access to prudential data on a regular basis

A significant part of the prudential data is in tabular format

IFRS 7 disclosures are mainly for investors and other

stakeholders

IFRS 7 disclosures are about risks based on accounting

framework

Can regulators learn more about the firms they supervise by

reviewing accounting disclosures?

Why analyse IFRS 7 disclosures?

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At the beginning of the crisis some regulators considered

analysing IFRS 7 disclosures as an early warning system:

Loan exposures

concentration of loan exposures to industries or

geographical regions

Impairment

Exposures through Special Purpose Vehicles (SPVs)

Foreign currency loans

Loans to emerging markets

IFRS 7 can in some cases provide to regulators the “big

picture” that data in a tabular format may miss

Example: IFRS 7 disclosures already provided information

about SPVs before the crisis

Why analyse IFRS 7 disclosures?

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According to IFRS 7: Providing qualitative disclosures in the context of quantitative disclosures enables users to link related disclosures and form and overall picture of the nature and extent of risks arising from financial instruments

According to IFRS 7: The interaction between qualitative and quantitative disclosures contributes to disclosures in a way that better enables users to evaluate an entity‟s exposure to risk

What does the above mean?

Important that words and numbers complete each other and are meaningful to users

Words explain the numbers

Words should be relevant and not “boiler-plate”

Words should be contextual

IFRS 7 disclosure requirements

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Qualitative disclosures (for market, credit and liquidity risk)

For each type of risk arising from financial instruments, an entity shall disclose:

The exposures to risk and how they arise

Its objectives, policies and processes for managing the risk and the methods used to measure the risk

Any changes from previous periods


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Classes of financial instruments and level of disclosure

When disclosure requirements are by class of financial instruments,

an entity shall group them by classes that are appropriate to the

nature of the information disclosed and that take into account the

characteristics of those financial instruments.

An entity shall provide sufficient information to permit reconciliation

to the line items presented in the statement of financial position

Implications

Users should be able to see the trail from notes to statement of

financial position and vice-versa

Information should be sufficiently detailed ie too much aggregation

not useful

Not to confuse between classes and categories (4 in IAS 39)


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By class of financial instruments

The amount that best represent its maximum exposure to credit risk

without taking into account collateral

Description of collateral held as security

Information about credit quality of financial assets that are neither past

due nor impaired

For either past due or impaired financial assets:

An analysis of the age of financial assets that are past due as at the end

of the reporting period but not impaired; and

An analysis of financial assets that are individually determined to be

impaired as at the end of the reporting period , including the factors the

entity considered in determining that they are impaired

If collateral meets the recognition criteria in other IFRSs, an entity shall

disclose the nature and carrying amount of the assets

IFRS 7 disclosure requirements – Credit risk

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Credit risk: the risk that one party to a financial

instrument will cause a financial loss for the other party

by failing to discharge an obligation

Past due: a financial asset is past due when a

counterparty has failed to make a payment when

contractually due


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Disclosures required for credit risk (and also market and liquidity

risk) should be given in the financial statements or incorporated by

cross-reference from the financial statements to management

commentary or risk report available to users of the financial

statements

Without the information incorporated by cross-reference, the

financial statements are incomplete

When management uses several methods to manage risks, the

entity shall disclose information using the method or methods that

provide the most relevant and reliable information


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Market risk: The risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices. Market risk comprises 3 types of risk: currency risk, interest rate risk and other price risk

Currency risk: The risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in foreign exchange rates

Interest rate risk: The risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates

Other price risk: The risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices (other than interest rate or currency risk) eg equity or commodity

IFRS 7 disclosure requirements – Market risk

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Sensitivity analysis

To reflect the impact of market risk on the valuation of the

financial instruments, the entity shall disclose a sensitivity

analysis for each type of market risk, showing how profit or

loss and equity would have been affected by changes in the

relevant risk variable that were reasonably possible at that

date

To disclose: Methods and assumptions used in preparing the

sensitivity analysis

To disclose: Changes from previous period in the methods

and assumptions used and reasons for such changes


Sensitivity analysis is a kind of stress test with less radical

assumptions

Although supervisors may have access to more detailed data

re. sensitivity analysis or may require firms to perform more

stringent tests on the impact of market risks on profit and loss

and capital, the IFRS 7 disclosures on market risk is a good

place to start

Supervisors can also review these disclosures to check for

consistency with prudential data


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Section 2 ‒ Analysing disclosures: Prudential

filters

Section 2 will cover prudential filters and the key disclosures

related to prudential filters

The section will explain why prudential filters are used and

discuss what developments can we expect around prudential

filters

Objectives of prudential filters and related disclosures

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Why do we need prudential filters?

Accounting standards may affect the magnitude, quality and

volatility of bank‟s available capital

The IASB defines fair value as “the amount for which an asset

could be exchanged, or a liability settled, between

knowledgeable, willing parties in an arm‟s length transaction”

(IAS 39.9)1

Use of this measurement basis gives information that is more

relevant to users of the financial statements, but the results

can be less reliable and more volatile than using historical

cost conventions


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Because of the inherent volatility in the measurement basis of

some instruments under IFRS , it was deemed necessary to

smooth the impact of this volatility on prudential capital

Prudential filters was henced introduced only in specific cases

To summarise we need prudential filters to:

Remove or reduce volatility

Address effects of accounting standards on components of

capital

The prudential filters listed in the next slides are the most

common form of prudential filters


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Gains/losses on available for sale debt securities

Own credit spread

Defined benefit pension fund

Gains/losses on available for sale equities

Cash flow hedging reserves

List of prudential filters

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Gains and losses on AFS debt are unrealised

Some assets in this category are not actively traded

Fair value of these instruments are volatile

A prudential filter is applied to gains and losses on AFS debt

In some countries, a prudential filter is also applied for AFS

equities

Prudential filters ‒ Available For Sale debt

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The actuarial gains and losses on pension liabilities can be

large and volatile

The filter is applied because the liabilities are long term and

will not need to be funded over a period of 12 months

Prudential filters ‒ pension liabilities

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Cash flow hedges are used to swap fixed for floating cash

flows

The different treatments of a derivative instrument used as a

cash flow hedge (at fair value) and the hedged exposure

could potentially create significant volatility in equity. This

volatility arises because the portion of the fair value gain or

loss on the cash flow hedging instrument that is determined to

be an effective hedge is recorded in equity, but there is no

corresponding loss or gain recorded against the hedged

exposure

The hedging instrument is a derivative measured at fair value

The hedged item is usually measured at cost

A filter is applied to reverse the fair value gain or loss in equity

Prudential filters ‒ cash flow hedges

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Section 3 ‒ IFRS 7 and capital disclosures

developments

The third and last section of this session will explain

developments and on-going work taking place in the area of

public disclosures by accounting standard setters and

regulators

Despite the number of changes made in IFRS 7 and changes

recommended by regulators over the past 3 years, there are

still a number of initiatives taking place on public disclosures

IFRS 7 and capital disclosures developments

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Increasingly in the spotlight since the crisis

Regulators analyse financial statements and the public

disclosures (Pillar 3 and IFRS 7) since the beginning of the

crisis

Senior Supervisors Group (SSG) also performed a cross-

banks analysis at the beginning of the crisis

Exercise of the SSG is currently being repeated

Various exercises tend to compare and contrast the

disclosure practices across banks and look at good versus

bad examples and also at outliers

IFRS 7 developments

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Key areas considered tend to vary depending whether you

are analysts, regulators, etc.

For example disclosures around CDSs; securitisations, CDOs

were hot topics at the beginning of the crisis

More recently disclosures around valuations and sensitivity

analysis have become hot topics

Disclosures and analysis of disclosures should be seen as an

evolution and a never ending game

It is a continuous process

IFRS 7 developments

Basel Committee on Banking Supervision (BCBS) has

recently published a consultation paper on: Definition of

capital disclosure requirements- A consultative document

The reason to publish the paper was:

“Many market participants and supervisors have attempted

to undertake detailed assessments of the capital positions

of banks and comparisons of their capital positions on a

cross jurisdictional basis. The lack of consistency in the

way that it was reported typically made this task difficult

and often made it impossible to do with accuracy.” BCBS

December 2011


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According to the paper: to achieve a meaningful comparison,

it is essential that banks disclose the full list of capital items

and regulatory adjustments

BCBS believes “…banks should be required to publish their

capital positions according to common templates

BCBS is also proposing a common disclosure template post 1

January 2018

The template is designed to disclose all regulatory

adjustments to enhance consistency and comparison in the

disclosure of the elements of capital between banks and

across jurisdictions


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The BCBS is also proposing some disclosures on or after

January 2013

A common template is proposed for banks to use to meet

Basel III requirements to provide a description of the main

features of capital instruments

Banks should publish the completed disclosure template (post

January 2018) with the same frequency as the publication of

their financial statements (typically quarterly or half yearly)

Template should be included in the banks‟ published financial

reports or at a minimum these reports should provide a direct

link to the completed template on the banks‟ website

Banks should also make available on their website an archive

of all templates relating to prior reporting periods


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BCBS is also proposing new disclosures re. a full

reconciliation of all regulatory capital elements back to the

balance sheet in the audited financial statements

The objective of the above disclosure is to address the

problem that there is currently a disconnect in many banks „

disclosure between the numbers used for the calculation of

regulatory capital and the numbers used in the published

financial statements

The disconnect is mainly because the scope of consolidation

is different between accounting and prudential framework

However there is no template for the reconciliation disclosures


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Regulators are increasingly paying attention to public

disclosures even if they have access to more frequent and

more detailed information from the industry

Public disclosures may provide the “big picture” view and

could act as an early warning system

Conclusions

“When investors and analysts want to know how the

banking industry is performing or well governed in a

particular jurisdiction, they do not always discuss with

the regulators…they analyse the financial statements

of the firms. The quality of financial statements may

reflect the quality of regulation in a particular

jurisdiction” An analyst

The views expressed in this presentation do not

necessarily reflect those of the Executive Directors of

The World Bank or the governments they represent.

Thank you

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