FS IAS

Impact of IAS on the Banking Industry

n Hedge accounting is complex
Not all economic hedges will qualify
for hedge accounting and those
Banks across Europe will be significantly affected by the proposed EU requirement to adopt
that do qualify will require detailed
International Accounting Standards. There are indications that all banks, not only those that documentation and testing of
are listed, will be required to prepare their financial statements in accordance with IAS. effectiveness throughout the life
Accounting standards in many countries have become more harmonised with IAS in many of the hedge relationship.

respects, but even in these countries adoption of certain rules within IAS, in particular IAS
39 on financial instruments, will require a considerable effort. The magnitude of the task of
converting to IAS will depend on the gaps between local accounting standards and IAS.
Top accounting issues
For a bank, the following are likely
to be the key issues arising from
implementation of IAS, although the
actual impact will depend on the type
of business carried out and the
economic environment in which
the bank operates:
n Required use of fair value for more
financial instruments
All financial instruments (except
loans originated by the enterprise
and a restricted category of “held-to-
maturity” assets) must be stated at
fair value. This will have a significant
impact on banks’ investment
portfolios especially where currently
accounted for at amortised cost. As
these portfolios are also usually held
for liquidity and risk management
purposes with individual holdings
being disposed of as and when
required, it will not be possible to
designate them as “held-to-
maturity”.
n Mismatch of assets and liabilities
While there are more financial
assets carried at fair value, the same
is not true for financial liabilities.
Only derivative and trading liabilities
are stated at fair value. This may
increase the volatility of a banking
institution’s income.
n Derivatives accounting
All derivatives have to be stated at
fair value, with changes to carrying
value recorded in income (or equity
for certain hedge relationships). The
definition of a derivative is wide and
includes certain contracts which are
not commonly thought of as
derivatives. IAS 39 introduces the
concept of an “embedded
derivative” which has to be
separated from the host contract
and stated at fair value. Banks will
have to review their portfolios of
assets and liabilities as well as
commitments to make sure that
they identify all derivatives and all
embedded derivatives.
n Impairment provisions
Impairment provisions on loans
and other financial assets have to
be calculated using expected future
cash flows and applying discounting.
Provision amounts will depend not
only on the recoverability of the loan
principal but also of interest.
Current policies such as suspension
of interest will need to be revised
in order to comply with IAS
requirements on impairment loss
recognition.
n Purchased loan portfolios have
different accounting treatment
Depending upon future intent,
purchased loans may be classified
as “Trading”, “Available for sale”
or “Held to maturity” with each
category having a prescribed
accounting treatment of either
fair value or amortised cost. This
requirement will impact banks that
acquire rather than originate loans,
as they may be required to account
for these on a fair value basis rather
than the more customary amortised
cost.
The above issues represent only some
of the accounting issues that will have
to be considered. There are many more
and some may be particularly relevant to
the specific activities carried out by the

Financial Services
individual banking group. Implementation of the new Basle
Adoption of IAS will also lead to new accord, currently scheduled for 2005
disclosure requirements. For some and therefore coinciding with the
countries, these will be more IAS implementation date, will create
comprehensive than the existing rules, additional pressure on resources.
but most banking institutions will find
that there is a significant amount of How KPMG can help
new data to be collected especially in KPMG has helped many financial
the area of financial risk management. institutions in assessing the impact
of and implementing IAS. We have
Adoption of IAS is more than just an developed a range of tools for such a
accounting change process, ranging from a quick
Clearly, implementation of IAS will assessment of the complexity of the
require a considerable effort from the project, estimate of high level financial
bank’s accounting staff. New accounting impact on income, equity and balance
policies will have to be drafted, sheet to a more comprehensive review,
consolidation reporting packs changed, including implementation. Our
internal manuals amended and training professionals in technical aspects of IAS
provided. But other areas will also be for the banking industry, regulatory and
affected: compliance requirements, systems and
project management will work together
n Systems changes will be necessary, to assist in what is likely to be a
both in the source and consolidation complex project for most banks.
systems. Early consideration of the
IAS requirements will allow these If you would like to know more about
to be incorporated into any planned our IAS conversion services for banks
system enhancements or get in touch with your usual KPMG
replacement; contact or the leader of our Banking
Practice:
n Front office transactions and risk
management - changes brought Brendan Nelson
about by the implementation of IAS Chairman Global Banking
will impact many financial structures KPMG
developed by the front office, such One Canada Square
as securitisations, and mitigating Canary Wharf
actions will be required to ensure London
that the desired accounting E14 5AG
objectives are met. Changes in Tel: +44 (0)20 7694 6157
risk management policies and Email: brendan.nelson@kpmg.co.uk
procedures will often be necessary
in order to be able to apply hedge
accounting and reduce volatility
of earnings.

n Regulatory - accounting policy

changes may impact calculation
of regulatory ratios and positions
subject to regulatory limits although
the approach in this area is likely to
develop over the next few years. The
regulator’s risk rating for a bank will
be affected by increase in volatility
of its earnings.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate
and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon
such information without appropriate professional advice after a thorough examination of the particular situation

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