ALMA is concerned that some of the IASB’s proposals are not in line
with practice in its member banks and may be too difficult to implement.
The UK Asset and Liability Management Association (ALMA) accepts that
bringing accounting for risk exposure into line with economic exposure
is an aim of the International Accounting Standards Board (IASB) and it
wishes to support the board in this regard. It is concerned, however,
that valuation-oriented accounting rules will not convey information on
the sensitivity of net asset values to changes in underlying market
variables. Therefore, it has argued for greater disclosure of value and
income volatility of banks’ balance sheets, through scenario analysis,
and for incentivising the reduction of value and income volatility of
banks’ balance sheets, through developing and disseminating best
practice hedging techniques.
ALMA recognises the contribution of the Basel Committee on Banking
Supervision in the pursuance of these objectives through the creation
of the Basel II Accord. It is most concerned to ensure that pressures
on its members to minimise the income and value volatility of financial
reports prepared under international accounting standards should not
disincentivise the presence of best practice hedging of bank balance
sheets in accordance with Basel II. In particular, it has four major
concerns with respect to IAS39 and its proposed implementation.
1. Core deposits
IAS39 defines a core deposit as a liability with no specified maturity
that is repayable on demand or after a notice period, but the standard
requires that “core deposit cannot qualify for fair value hedge
accounting for any time period beyond the shortest period in which the
counter party can demand payment”. This approach is based on a
definition that ALMA rejects.
A body of literature and statistical studies establish the stability of
current account balances across society and in individual banks’
balance sheets. Banks use this stability as a basis for the behavioural
definition of current accounts. The IASB is willing to accept the
behavioural nature of many retail banking contracts but there is
concern that it is unwilling to accept this logic being carried into a
product area where it is so well established in theory and in practice.
2. Best practice
ALMA is pleased that, under phase 2 of the Basel II Accord, best
practice for asset and liability management (ALM) will increase
emphasis on robust process audits of ALM systems and associated
processes. It has encouraged its members to implement such processes
and systems. It is concerned, therefore, that the IASB is unable to
accept the “net ladder” financial risk position produced by such
rigorously audited processes and systems as the “hedged item”.
ALMA believes the net ladder should be defined as the hedged item and
that the audit of the ALM process should give sufficient comfort that
this is correct. The net ladder is a complex construct of millions of
transactions with complex and offsetting behaviour-adjusted risk
profiles brought together through the aggregation inherent in its ALM
system. Any attachment of the net position to specific underlying
retail transactions as defined for IAS39 purposes and as proposed by
the IASB would be a forced construct and encourages a rules-based
approach that dissociates the accounting practice from the risk
management process.
3. Risk sharing
ALMA is happy to encourage the development of deeper and more liquid
derivatives markets that hold out the prospect of greater risk-sharing
efficiency for society as a whole. The IASB’s assertion that banks
cannot separate pre-payment risk from interest rate risk and hedge
these separately is of concern, therefore.
As a matter of practice, and due to time horizons of the risk and
liquidity of exotic derivatives markets, many banks choose not to
separate these risks. So there is some income volatility from this
strategy. As derivatives markets develop, the risk premium associated
with hedging such risks will be reduced and customer demand is likely
to change. In these circumstances, IAS39 accounting rules may
disincentivise banks from disaggregating their interest and pre-payment
risks and entering into transactions that would severally manage these
risks, and enhance consumer choice and welfare through the offering of
longer-dated fixed rate loan products
4. Hedging exposures
The IASB has outlined four possible approaches for hedging part of
an exposure effectively. All have merit. But by proposing that only one
will be acceptable, it is prescribing risk management techniques. This
issue is still open to consultation and ALMA believes that the IASB
should not be discouraging financial institutions from using the most
appropriate approach to provide an effective economic hedge and that
this should be recognised in the standard.
Difficult to implement
ALMA believes that the IASB’s proposed approach ‘D’ would not be in
line with practice in member banks and would be difficult to implement
in an ALM system. It notes that approaches ‘A’ and ‘C’ are both used by
members.
The association has many detailed concerns about the draft proposals of
IAS39 and IAS32. However, its view is that the IASB should address as a
priority the above matters of principle to ensure that new accounting
rules encourage the best possible risk management of the banking system
in the interest of shareholders, customers, economic policy makers and
society as whole.
UK Asset & Liability Management Association
