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         V. Emerging Issues
         










 

Sound Practices for Loan Accounting, Credit Risk Disclosure and Related Matters

V. Emerging Issues

    (a) Fair value accounting and disclosure

      (i) Fair value accounting

  1. Leading accounting standard-setters are currently discussing advantages and disadvantages of moving toward greater use of fair value accounting for financial instruments. In particular, the International Accounting Standards Committee (IASC) and several national accounting standard-setters are undertaking a joint project focusing on the prospects of introducing comprehensive fair value accounting for financial assets and financial liabilities.

  2. Without prudent and balanced standards for the estimation of fair values, particularly when active markets do not exist (such as is often the case for loans), the use of a fair value model could reduce the reliability of financial statement values and increase the volatility of earnings and equity measurements.

  3. The Basle Committee believes that fair value accounting is appropriate when such an approach is workable, e.g., for financial instruments held for trading purposes. However, more work is necessary to provide the appropriate guidance on the estimation of fair values and on the treatment of the value adjustments before this system of accounting can be extended to all banking book financial assets and liabilities. While many of the goals of the fair value approach are desirable, the Basle Committee has serious reservations about the adoption of comprehensive fair value accounting in the balance sheet and income statement at the present time, as was outlined for example in a 1997 IASC discussion paper.

      (ii) Fair value disclosure

  4. As an alternative approach to full fair value accounting, the Basle Committee believes that disclosure requirements for major market participants could be expanded to include supplemental disclosure of fair value of financial instruments on a consolidated basis along with additional quantitative and qualitative disclosures. The disclosure of fair value information in respect of financial instruments may be a useful addition to assist preparers to experiment with different presentations and to assist readers to gain a better understanding of the size and movements of the figures involved.

  5. In some countries that are represented on the Basle Committee, banks and other companies are required to disclose the fair value of their financial instruments, including their loan portfolio. These requirements are also set forth in the standards of the IASC (IAS 32). Institutions that do provide supplemental fair value disclosures should disclose the methods adopted to determine the fair values, any significant assumptions used in its estimation and are encouraged to discuss issues associated with the estimation of fair values.

    (b) New approaches to credit risk provisioning

  6. Some banks are exploring approaches to loan provisioning that rely on credit modelling techniques. Under these techniques, banks attempt to measure exposure to credit risk over a longer-term horizon than traditionally has been the case, and allowances under this approach may be set up earlier than otherwise. Such loan loss allowances are based on statistical analyses of historical loss data and other factors, from which the institution derives forecasts of future loss behaviour. The statistical techniques used may be similar to those underlying banks' credit risk management and pricing models.

  7. The Basle Committee has been studying industry practice in the area of credit models more generally. It recognises that advances in credit modelling techniques also may have implications for how internationally active banks determine and assess the adequacy of their overall loan loss allowance. From a supervisory perspective, it is desirable that accounting principles be able to accommodate appropriate use of statistical methodologies that fairly and realistically portray a bank's financial position, financial performance and risk management activities. The Committee, therefore, will keep these developments and the issues they present under review to determine whether they improve the quality of loan loss provisioning, and may provide further guidance on the use of these provisioning techniques as they evolve.

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