Financial Statement of Prudential - PowerPoint

Document Sample
Financial Statement of Prudential - PowerPoint Powered By Docstoc
					April 28, 2009



International Financial Reporting Standards




                                                            Issues will be tackled by
                                                         accounting standard-setters
                                                                   in the near future




The views expressed in this presentation are those of the presenters,
not necessarily those of the IASB
Issues is been tackling                                    2



• Simplification of accounting for financial instruments
• Impairment of loans and receivables:
Simplification of accounting for
financial instruments                       3




                                   Accounting
                                   standards on
                                   financial
                                   instruments
                                   are too
                                   complicated!
Simplification of accounting for
financial instruments                                                         4


                       Definitions of      Cash flow
      Embedded                                             Fair value
                     different types of     and FV
      derivatives                                           option
                             FI             hedge
                                          accounting




                      Change of           Gains/losses     Impairment of
   Different
                     measurement              on             cost-based
measurements
                       method                              assets: trigger,
 for different                            de-recognition   measurement,
  types of FI       Reclassification                          reversal
Simplification of accounting for
financial instruments                                    5



                       IASB alone has 22 different
         Simplify      ways of valuing a financial
                       assets based on:
                            4 different categories
                            7 different impairment methods

                            Other complicated issues


                          IASB Discussion Paper
                           issued on March 19, 2008,
                           asking which way to go?
                               Long-term approach?
                               Intermediate approach?
                               Something else?
Simplification of accounting for
financial instruments                                                              6


• Long-term approach: single measurement method ?
   – Question: What is the appropriate single measurement attribute for
     all types of financial instruments?
   – Some people believe fair value seems to be the only appropriate
     measurement method.
   – Using fair value could reduce some of today’s complexity, but...
       – Fair value may introduce or increase complexity
            – Components of changes in fair value; illiquidity issues
       – Some important issues need to be addressed first
            – Does it represent well the actual business model of all banks or other
              entities?
            – How should performance be presented
       – It might take a long time to resolve those issues
       – It seams hard to reach consensus among standards setters and
         constituencies.
 Simplification of accounting for
 financial instruments                                             7


• Intermediate approach
    Amend existing measurement requirements (eg by reducing
     number of categories of financial assets)
    Replace existing measurement requirements with a fair value
     measurement principle plus some optional exceptions
    Simplify hedge accounting only
Simplification of accounting for
financial instruments                                                      8


• Approach decided by IASB-FASB joint meeting in March
  2009, and supported by London G20 Summit
   – Objectives
       – replace with a common standard that will significantly improve the
         decision-usefulness for users of financial statements.
       – lead to simpler accounting requirements.
       – although the project objective is comprehensive, the project should be
         addressed expeditiously.
   – Potential measurement methods
       – fair value
       – amortised cost
       – method based on discounted cash flows
Simplification of accounting for
financial instruments                                                      9


  – Possible criteria
      – characteristics of the instrument, such as cash flow variability
      – business model of the entity
      – the entity’s intention and/or ability to trade the instrument.
  – Time to finish
      – By the end of 2009
So what will the future looks like?      10




      Rules                 Principles
 Impairment of loans and receivables:
 incurred loss model versus dynamic provisioning                              11



• Background
   – Creating contra-cyclical incentives, including measures in the
     prudential regulation of financial institutions, feature at a high level in
     the reform agenda of governments and international experts groups.
   – “Dynamic provisioning” of the credit risks inherent in banking portfolios
     has been cited by some as a necessity.
   – There is no international agreement yet on the workings of a
     standardized dynamic provisioning system.
   – G20 requirement: start to implement the recommendation by G20 to
     mitigate pro-cyclicality, including a requirement for banks to build
     buffers of resources in good times that they can draw down when
     conditions deteriorate, with a deadline of end of 2009.
Evolution of “weather conditions” during the life of a
loan portfolio – when should impairments be reported?                         12


Origination of the loans when it     “Loss event” according to IAS39.59
is sunny. IAS39.59 precludes        requires impairment based on
                                                                          Loan becomes
provision                            observable evidence; e.g. default or
                                                                          uncollectible;
                                     delinquency in interest or principal
                                                                          Write off
      It becomes cloudy or grey: Economic
      situation deteriorates losses are
      expected Impairment?                                                           t
 t0




                                                     Date of
                                                     Balance sheet
Impairment of loans and receivables: incurred
loss model versus dynamic provisioning                                            13


 • The incurred loss model under 59 of IAS 39:
    – A financial asset is impaired if and only if, there is objective evidence
      of impairment as a result of one or more events that occurred after the
      initial recognition and that loss event has an impact on estimated
      future cash flows that can be reliably measured.
        – Losses expected as a result of future events, no matter how likely, are
          not recognized?
    – Observable evidence of impairment includes
        (a) Significant difficulty of the issuer or obligor
        (b) Breach of contract, such as a default or delinquency in interest or
           principal payments
        (d) It becoming probable that the borrower will enter bankruptcy…
  Impairment of loans and receivables:
  incurred loss model versus dynamic provisioning                           14

• Dynamic provisioning (DP) model used in Span from 2000:
   – During good times, banks have to set aside provisions for the expected
     losses that are embedded in expanding credit portfolios.
   – The provisions made during those years are used to build up so called
     statistical fund that might be depleted in bad times in the form of
     impaired assets.
   – By design, the DP produces flat loan loss provision ratios (i. e. loan loss
     provisions over total loans) through the economic cycle.
Impairment of loans and receivables:
incurred loss model versus dynamic provisioning                                    15



 • Some questions about DP
    – Who decides the quantum of the additional provisioning? How does
      one achieve comparability among issuers?
    – After a period of accumulation, how does one use the buffer when
      economic circumstances deteriorate? When does this begin and
      stop?
        – Reduce or stop allocations to the buffer?
        – Use buffer as a credit to P/L to offset reported credit losses? If so,
          under what objective rules?
        – How can one prevent the system to be used as a pure earnings
          management tool?
Impairment of loans and receivables:
incurred loss model versus dynamic provisioning   16


• Different views on this
  issue: Turner Review, 0903
   – A counter cyclical capital
     adequacy regime should be
     introduced, with capital
     buffers which increase in
     economic upswings and
     decrease in recession.
   – Published accounts should
     also introduce buffers
     which anticipate potential
     future losses, through the
     form of ‘economic cycle
     reserve.’
    Impairment of loans and receivables:
    incurred loss model versus dynamic provisioning                       17


•    Different views on this issue
     – Report by Group of 30; A Framework for Financial
       Stability, 090115
         •   “Accounting principles should also be made more flexible in
             regard to the prudential need for regulated institutions to
             maintain adequate credit-loss reserves sufficient to cover
             expected losses across their portfolios over the life of those
             assets. Full transparency of the manner in which reserves are
             determined and allocated.”
Impairment of loans and receivables:
incurred loss model versus dynamic provisioning                18


                           • Different views on this issue: EU
                             Commissioner C. McGreevy –
                             speech at the 7th Annual Financial
                             Services Conference – Brussels,
                             090127
                               – “I am concerned about other pro-
                                 cyclical elements that impact on
                                 the bank capital requirement
                                 regime, and in particular the issue
                                 of dynamic provisioning which
                                 enabled banks under the old
                                 accounting rules to build bigger
                                 buffers in good times in anticipation
                                 of portfolio impairment which
                                 invariably rises materially in less
                                 benign economic circumstances”
Impairment of loans and receivables:
incurred loss model versus dynamic provisioning      19


• Different views on this issue: Hans
  Hoogervorst, Chair of Netherlands Authority
  for the Financial Markets, and Chair of
  Monitoring Group of IASCF, Financial
  Times, 090402
    – “The accounting standards setters should
      consider if this Economic Cycle Reserve
      can be shown in financial statements
      without compromising transparency. By
      clearly showing the countercyclical capital
      requirements as mandated by prudential
      regulators, the financial statement could
      give at an aggregate level a useful
      indicator for possible distortions caused by
      the economic cycle. If properly executed,
      this could help investors to look through
      the effects of the economic cycle on the
      financial statement.”
Impairment of loans and receivables:
incurred loss model versus dynamic provisioning                                20



 • Different views on this issue
    – Philippe FOULQUIER and Samuel SENDER, Professors and Director
      of Research, EDHEC, Les Echos, 081110
        – “Regulation, not accounting standards, should be in charge of reducing
          systemic risks. Financial statements have an informative role, not a
          prudential role. To reduce the transparency of financial information
          under the pretext that it is pro-cyclical, would result in hiding the true
          exposure of banks to risks and magnify the lack of confidence of the
          financial markets participants.”
Impairment of loans and receivables:
incurred loss model versus dynamic provisioning                   21



 • How to fulfil the task charged by G20?
    – Alternative 1: Not change incurred loss model at all
        – Some accounting standard setters have such a view
        – Banks, regulators and politicians may be against
    – Alternative 2: Maintain incurred loss model + Appropriation of
      retained earnings
        – Accounting standard setter may be willing to do
        – Banks, regulators and politicians may not like to see
    – Alternative 3: Improve incurred loss model + Appropriation of
      retained earnings?
        – It may attract most of the people involved
Impairment of loans and receivables:
incurred loss model versus dynamic provisioning                         22


• Alternative 3-1: Improve incurred loss model by
  clarifying:
   – current provision model is not based on actually incurred but
     expected incurred loss
   – “the use of reasonable estimates is an essential part of the
     preparation of financial statements and does not undermine their
     reliability” (IAS39.62)
   – a forward looking analysis of the likely consequences of changes in
     current economic conditions is necessary to implement IAS 39.59 (f)
     or to estimate loss provision
   – past historical loss experience is a starting point but needs to take
     into account the most current evolutions of the economy (i.e.,
     models should be calibrated as often as necessary)
Impairment of loans and receivables:
incurred loss model versus dynamic provisioning                          23


• Alternative 3-1: Improve incurred loss model by
  clarifying:
   – correlation factors need to be sufficient but not necessarily very high
     to justify that observable data (a present loss event) exist at the time
     of preparing financial statements.
   – as soon as there is an observable significant adverse change in
     economic conditions, and if there is a sufficient understanding of its
     future consequences, so that the reporting entity is able to estimate
     the impact on its future cash flows, a loss event has occurred and
     provision should be made in financial statements.
 Impairment of loans and receivables:
 incurred loss model versus dynamic provisioning                            24


• Alternative 3-2: appropriation of retained earnings
   – Modern economies show a succession of upward and downward cycles.
     However, the frequency, amplitude and length pattern of those cycles is
     not constant and not yet very well known.
   – Financial stability of banks is key to the general economic stability, and is
     based on their ability to absorb shocks; this ability relies on the existence
     of sufficient capital at any point in time.
   – The transparency of their true financial condition is also key to investors
     and creditors in financial institutions. Absent this confidence, banks find it
     more difficult to refinance their operations when needed.
  Impairment of loans and receivables:
  incurred loss model versus dynamic provisioning                           25


• Alternative 3-2: appropriation of retained earnings
   – Beyond the accounting recognition of loss events in the P/L, banks should
     make appropriation of its retained earnings to create capital buffers during
     good times in order to weather future crises and recurrent downward
     economic cycles.
   – This can be achieved through different regulatory mechanisms, but the
     basic idea is to maintain adequate level of capital and to prevent banks
     from distributing a portion of their profits (through dividends, share buy-
     backs, and bonuses).
Reconcile the needs of investors and
that of prudential regulators                                       26


                              Balance sheet
   Information
                                                              Total equity
  for investors    Non financial
                     assets               Common and
                                           other stock          Statement
                   Banking book
                   (at cost less                                    of
                    Impairment)                                 Changes
                                              Distributable
Profit and loss                                                     in
                                               Earnings
   Account         - Loan loss                                    Equity
                     reserves            Non distributable
                                            Earnings
 Cost of risk

 Changes in        Trading book                                Prudential
 Fair value       (mark to market              Liabilities     regulatory
                   or to model)                               requirement
    Other
Comprehensive
   Income
                            Off balance sheet risks
April 28, 2009



International Financial Reporting Standards




                                                                        Concluding remarks




The views expressed in this presentation are those of the presenters,
not necessarily those of the IASB
Concluding remarks                                           28



• The whole world is now experiencing severe and prolonged
  financial and economic crisis
• This crisis has created unexpected challenge to accounting
  practitioners and standard-setters.
• The focal point is fair value measurement.
• Before the crisis is over, the accounting standards-setters
  will inevitably face more heavy pressures from different
  directions, interesting groups, regulatory bodies, as well as
  politicians.
Concluding remarks                                                        29

• Controversy over the relationship between current crisis and
  financial reporting, especially fair value measurement, requires
  us to review some of the fundamental conceptual issues, e.g.:
    – What is the basic objective of financial reporting?
    – Should financial reporting not only meet the needs of capital providers,
      but also meet the needs of macroeconomic policy makers and
      regulators?
    – Should accounting standards only be based on its conceptual
      framework, or also based on economic consequences?
    – Can the standard-setter process avoid possible political influence?
    – What is the appropriate measurement basis of entity’s financial
      position and performance, fair value, historical cost, or a mixed basis
      as we have been using for many years?
    – How should we make trade off between relevance and reliability,
      between historical and forecasted financial information?
Concluding remarks                                           30

• To find appropriate solution, we hope to see more constructive
  researches, and are interested in dialogue with accounting
  educators and researchers.
Questions or comments?             31



• The views expressed in this
  presentation are those of the
  presenters.
• Official positions of the IASB
  on accounting matters are
  determined only after
  extensive due process
  and deliberation.

				
DOCUMENT INFO
Description: Financial Statement of Prudential document sample