Prudential supervision and the evolution of accounting standards: the stakes for financial stability

The adoption in Europe of IFRS international accounting standards, which became mandatory for listed companies beginning 1 January 2005, brings undeniable benefits, most notably in improving the comparability of published financial statements. However, the potential impact of the IFRS on the behaviour of credit institutions, and the financial system as a whole, raises concerns from the perspective of financial stability. The new standards’ increased reliance on “fair value” may increase the volatility of balance sheets and income statements, and some of that increase may be artificial. The standards also complicate the application of the risk management techniques commonly used by credit institutions, and they often depart significantly from the principle of prudence. These uncertainties regarding the effect of the IFRS on the behaviour of institutions are reinforced by the absence of a body of interpretation – still to be constructed – which can provide answers to questions raised in the practical application of the new standards. Finally, the discretion provided to institutions by the “fair value option” may ultimately hamper the comparability of their fi nancial statements. These issues take on all the more importance from the perspective of bank supervisors, given that the IFRS have a direct impact on the calculation of the prudential ratios that play a central role in the supervision of credit institutions. The rapid rate of change in the international accounting framework makes it necessary for bank supervisors to remain watchful in this area, as regards in particular the potential introduction of a full fair value model. In response to these concerns, bank supervisors, working together at the international level, have developed a set of adjustments, referred to as “prudential filters”, which are designed to correct certain accounting values determined in accordance with the IFRS before they are used to calculate prudential ratios. The adoption of prudential filters does not, however, resolve all of the financial stability issues raised by the introduction of the IFRS. The coexistence of the international framework with national accounting standards can create problems, particularly when the different frameworks call for disparate treatments of the same transaction, as is currently the case for securitisation operations. This situation can complicate the operational management of banking groups, and can also introduce accounting distortions between institutions subjected to different accounting frameworks. Most seriously, it can encourage arbitrage between the different accounting frameworks. These considerations have led bank supervisors to disconnect the prudential treatment of certain banking operations from their accounting treatment.