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IFRS 7 Financial instruments: Disclosure 2011

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IFRS 7 Financial instruments: Disclosure

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We wish to especially thank Elizabeth Appraxine (European Union) who administered these TACIS projects, Richard J. Gregson (Partner, PricewaterhouseCoopers) who led the projects and all friends at Bankir.Ru for hosting the books.

TACIS project partners included Rosexpertiza (Russia), ACCA (UK), Agriconsulting (Italy), FBK (Russia), and European Savings Bank Group (Brussels). The help of Philip W. Smith (editor of the third edition) and Allan Gamborg, project managers and Ekaterina Nekrasova, Director of PricewaterhouseCoopers, who managed the production of the Russian version (2008-9) is gratefully acknowledged. Glyn R. Phillips, manager of the first two projects conceived the idea, designed the workbooks and edited the first two versions. We are proud to realise his vision. Robin Joyce Professor of the Chair of International Banking and Finance Financial University under the Government of the Russian Federation

Visiting Professor of the Siberian Academy of Finance and Banking Moscow, Russia 2011 Updated

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Contents

IFRS 7 Financial Instruments: Disclosures.......................4

Introductory Notes 4Definitions 7Main features of IFRS 7 10Objective of IFRS 7 11IAS 1 Presentation of Financial Statements Update (2007) 11Scope 12

Classes of financial instruments and level of disclosure...............12

Balance sheet (SFP) 16Categories of financial assets and financial liabilities....................16

Financial assets or financial liabilities at fair value through profit or loss 18

Reclassification...................................................................................20

Derecognition......................................................................................20

Collateral..............................................................................................21

Allowance account for credit losses................................................23

Compound financial instruments with multiple-embedded derivatives 23

Defaults and breaches........................................................................23

Profit and Loss Account and Equity...........................24Items of income, expense, gains or losses......................................24

Other disclosures 27Accounting policies............................................................................27



IFRS 7 Financial Instruments: Disclosures

Hedge accounting 29Fair value 37Nature and extent of risks arising from financial instruments 42

Qualitative disclosures......................................................................42

Quantitative disclosures....................................................................44

Credit risk............................................................................................48

Liquidity risk........................................................................................50

Market risk...........................................................................................53

Interest rate risk..................................................................................57

Currency risk.......................................................................................59

Other market risk disclosures.....................................62Transfers of financial assets 62Brief Notes on FINREP and Prudential Supervision of Banks 65

Note: Material from the following PricewaterhouseCoopers publications has been used in this workbook:

-Applying IFRS -IFRS News-Accounting Solutions


IFRS 7 combines all financial instruments disclosures in a single standard. The remaining parts of IAS 32 deal only with financial instruments presentation.

This workbook is complemented by our 5 workbooks on IAS 32/39 and IFRS 9 workbook.




IFRS 9 (effective from 2013) will replace IAS 39. As IAS 39 is still in use, its elements remain in this workbook. We will produce an IFRS 9 version of this IFRS 7 workbook.

Introductory NotesIFRS 7 is applicable to all enterprises including banks which make much greater use of financial instruments.

IFRS 7 requires qualitative and quantitative analysis of currency, interest rate, liquidity and other price risk.

IFRS 7 is a comprehensive disclosure standard that applies to all companies. It provides the market with more information about an undertaking’s financial assets and liabilities, and their associated risks. It requires disclosures about:

the significance of financial instruments for an undertaking’s financial position and performance, including many of the requirements currently in IAS 32; andthe nature and extent of risks arising from financial instruments.

Management must identify and consider the key messages it wishes to communicate to the market via the new disclosures. These disclosures provide a significant opportunity for undertakings to explain their risk management processes.

There is the risk of a negative market reaction if the enhanced and more transparent disclosures reveal weaknesses in those processes. The disclosures (especially those related to risk) will require considerable resources to develop and draft.

The changes brought by the new standard can be split into four key

areas:

-disclosing risk ‘through the eyes of management’;

-expanded quantitative disclosures of risk;

-the introduction of sensitivity analysis; and

-enhanced disclosure of an undertaking’s financial position and performance.

They apply to all undertakings. However, the extent of disclosure required will reflect the undertaking’s use of financial instruments.

Undertakings that make more use of financial instruments and have greater associated exposure to risk will need to give more disclosures.

Disclosing risk ‘through eyes of management’

IFRS 7 requires quantitative (numbers) and qualitative (financial position and performance) disclosures about an undertaking’s exposure to credit risk, liquidity risk and market risk arising from its use of financial instruments. It requires the following qualitative disclosures for each type of risk:

-the exposures to the risk and how they arise;

-the undertaking’s objectives, policies and processes for managing the risk;

-the methods used to measure the risk; and




-any changes to the above disclosures from the previous reporting period.

The standard also requires summary quantitative data about the undertaking’s exposure to each type of risk at the reporting date. This information is to be given ‘through the eyes of management’ ie, based on internal reports provided to management.

Certain minimum disclosures are also required to the extent they are not already covered by the ‘through the eyes of management’ information.

Undertakings are required to communicate to the market how they perceive, manage and measure risk.

This change to a ‘through the eyes of management’ approach will enable the market to better evaluate the strength (or otherwise) of an undertaking’s risk management activities.

Expanded quantitative disclosures of risks

The quantitative minimum disclosures of interest rate risk and credit risk have been expanded. In particular:

the quantitative disclosures for credit risk include the amount of exposure to credit risk at the reporting date by each class of financial instrument (trade debtors are captured by this requirement); and

on liquidity risk, disclosure of financial liabilities categorised by their earliest contractual maturity date and a description of how the undertaking manages the liquidity risk inherent in these financial liabilities is required.

For example, an undertaking that uses a stand-by line of credit to manage their liquidity risk should disclose this fact.

Introduction of sensitivity analysis

The final, and in some respects most challenging, new disclosure requirement is a sensitivity analysis for each component of market risk to which an undertaking is exposed (currency risk, interest rate risk and other price risk).

Every undertaking should disclose the impact of reasonably possible movements in each relevant market risk variable on profit and loss and equity. The format and presentation of this disclosure is not prescribed in the new standard.

The application and implementation guidance, however, offers advice on preparing the analysis. They also include an example illustrating that the analysis can be simple; they show, for example, the effect on post-tax profit of a 10 basis-points increase in interest rates and a 10% weakening of a key exchange rate.

Disclosure of a sensitivity analysis will be new for many undertakings, in particular those outside of the financial sector. Its preparation may prove challenging for undertakings without sophisticated risk management systems.

Enhanced disclosure of financial position and performance

IFRS 7 requires enhanced balance sheet and income statement disclosures. Below are three examples:

-disclosure of the carrying amount and net gains/net losses for each of the categories of financial instruments in IAS 39 (ie,




held-for-trading, available-for sale, etc). This will provide increased transparency of the financial performance of the various categories of instruments. Analysts and investors will be interested in this information;

-disclosures when hedge accounting is used. These include the ineffectiveness recognised in profit or loss for each type of hedge (fair value hedges, cash flow hedges and hedges of net investments in foreign operations). These will highlight the performance (including any ineffectiveness) of an undertaking’s hedging activities; and

-disclosure of movements on the allowance account, if an undertaking uses such an account to record credit losses. This is mainly relevant to the banking industry, where analysts and investors view the level of the provision for credit losses and movements in that provision as key performance indicators.

Adoption of IFRS 7

IFRS 7 contains application guidance and implementation guidance to help undertakings implement its requirements. The disclosures (especially those related to risk) will require considerable resources to develop and draft. Management should begin to consider the issues and understand that the disclosures will give the market more information with which to make judgments on risk management strategies and effectiveness.

IFRS News - December 2005

DefinitionsThere is only one basic type of risk, that is, an asset or liability may not liquidate at the planned value. There are a number of ”risks” that are considered below, but they subdivisions of the one basic risk and represent a subset of basic risk.

amortised cost of a financial asset or financial liability

This is the written-down cost. It is calculated as:

the amount at initial recognition

minus principal repayments,

plus or minus the cumulative amortisation of the difference between the initial and the maturity amounts, and

minus any reduction for impairment or bad debt risk.

available-for-sale financial assets

Available-for-sale financial assets are those non-derivative financial assets that are so designated.

This is a default classification. It applies to any financial assets that are not classified as

(i) loans and receivables,

(ii) held-to-maturity investments or

(iii) financial assets at fair value through profit or loss.

credit risk The risk that one party to a financial instrument will cause financial loss for the other party by failing to pay or discharge an obligation.

currency risk The risk that the fair value or future cash flows of a financial instrument will fluctuate due to changes in foreign exchange rates.




derecognition

Derecognition is the removal of an asset or liability from the balance sheet.

derivative A derivative is a financial instrument or other contract with all three of the following characteristics:

(i) its value changes in response to the change in a:

specified interest rate,

financial instrument price,

commodity price,

foreign currency rate,

index of prices or rates,

credit rating or credit index, or

other variable;

(ii) it requires little or no initial net investment; and

(iii) it is settled in the future.

effective interest method

The effective interest method calculates the amortised cost of financial assets or financial liabilities by allocating any premium or discount and interest income or interest expense over the relevant period.

equity instrument

An equity instrument is any contract that provides a positive residual interest in the assets of an undertaking after deducting all of its liabilities.

fair value Fair value is the amount for which an asset could be exchanged, or a liability settled, between

knowledgeable, independent parties.

financial asset A financial asset is any asset that is:

(i) cash;

(ii) an equity instrument of another undertaking;

(iii) a contractual right:

-to receive cash or a financial asset from another undertaking; or

-to exchange financial assets or financial liabilities with another undertaking under conditions that are potentially favourable to the undertaking; or

(iv) a contract that may be settled in the undertaking’s own equity instruments and is either:

-a non-derivative for which the undertaking may be obliged to receive a variable number of the undertaking’s own equity instruments; or

-a derivative that can be settled other than by a fixed amount of cash or a fixed number of the undertaking’s own equity instruments.

financial instrument

A financial instrument is any contract that involves a financial asset (including cash) of one undertaking and a financial liability or equity instrument of another undertaking.




financial liability A financial liability is any liability that is:

(i) a contractual obligation:

-to deliver cash or a financial asset to another undertaking; or

-to exchange financial assets or financial liabilities with another undertaking under conditions that are potentially unfavourable to the undertaking; or

(ii) a contract that can be settled in the undertaking’s own equity instruments and is either:

-a non-derivative for which the undertaking may be obliged to deliver a variable number of the undertaking’s own equity instruments; or

-a derivative that can be settled other than by a fixed amount of cash or a financial asset for a fixed number of the undertaking’s own equity instruments.

financial asset or financial liability at fair value through profit or loss

A financial asset or financial liability at fair value through profit or loss is a financial asset or financial liability that meets either of the following conditions.

(i) It is recorded as held for trading. A financial asset or financial liability is recorded as held for trading if it is:

-acquired or incurred primarily to sell or repurchase it soon;

-part of a portfolio of financial instruments that are managed together and for which there is a recent pattern of short-term profit-taking; or

-a derivative (except for a derivative that is a designated hedging instrument).

(ii) Upon initial recognition it is recorded as at fair value through profit or loss. This applies to any financial asset or financial liability except for:

investments in equity instruments that do not have a quoted market price in an active market, and whose fair value cannot be reliably measured.

financial asset or financial liability held for trading

Trading generally reflects active and frequent buying and selling, and these financial instruments are mostly used to generate a profit from short-term fluctuations in price or dealer's margin.

Financial liabilities held for trading include: i. derivative liabilities that are not accounted for as hedging instruments;

ii. obligations to deliver financial assets borrowed by a short seller (that is selling financial assets it has borrowed and does not yet own);

iii. financial liabilities that are incurred with an intention to repurchase them in the near term (such as a quoted debt instrument that the issuer may buy back soon depending on changes in its fair value); and




iv. financial liabilities that are part of a portfolio of identified financial instruments that are managed together and for which there is evidence of a recent pattern of short-term profit-taking.

The fact that a liability is used to fund trading activities does not in itself make that liability one that is held for trading. A bank overdraft would be an example of a liability used to fund trading that would not be recorded as held for trading.

forecast transaction

A forecast transaction is a future transaction where commitment has not yet been made.

hedging instrument

A hedging instrument is a designated derivative or (in the case of a hedge of changes in foreign currency exchange rates only) a designated non-derivative financial asset (liability) whose fair value or cash flows are expected to offset changes in the fair value or cash flows of a designated hedged item.

held-to-maturity investments

Held-to-maturity investments are non-derivative financial assets with determinable payments and fixed maturity that an undertaking can and will hold to maturity other than those recorded as:

(i) at fair value through profit or loss;

(ii) available for sale; and

(iii) loans and receivables.

interest rate risk

The risk that the fair value or future cash flows of a financial instrument will fluctuate due to changes in market interest rates.

liquidity risk The risk that an undertaking will have difficulty in settling its obligations.

loans and receivables Loans and receivables are non-derivative financial

assets with determinable payments that are not quoted in an active market, other than:

(i) those that the undertaking intends to sell immediately or soon, which shall be recorded as held for trading, and those that the undertaking designates as at fair value through profit or loss;

(ii) those recorded as available for sale; or

(iii) those for which the holder may not recover most of its initial investment, other than because of credit deterioration, which shall be recorded as available for sale.

An interest acquired in a pool of assets that are not loans or receivables (such as an interest in a mutual fund) is not a loan or receivable.

loans payable

Financial liabilities, other than short-term trade payables on normal credit terms.

market risk The risk that the fair value of future cash flows of a financial instrument will fluctuate due to changes in market prices. Market risk comprises three types of risk: currency risk, interest rate risk and other price risk.

(Market risk is thus a composite of currency risk,




interest rate risk and other price risk. Each may individually or jointly impact market prices.)

other price risk

The risk that the fair value or future cash flows of a financial instrument will fluctuate due to changes in market prices (other than those arising from interest rate risk or currency risk).

past due A financial asset is past due when a counterparty has failed to make a payment when contractually due.

regular way purchase or sale

A regular way purchase (or sale) is a purchase (or sale) of a financial asset under a contract whose terms require delivery of the asset within the time established by regulation or convention in the market specified.

Main features of IFRS 7

IFRS 7 applies to all risks arising from all financial instruments, except those exempted in the ‘Scope’ (below).

IFRS 7 applies to all undertakings, even undertakings that have few financial instruments such as a trader whose only financial instruments are accounts receivable and accounts payable.

The disclosure required varies with use of financial instruments and risk exposure.

Disclosure is required of:

(i) the impact of financial instruments on an undertaking’s financial position and performance. This updates IAS 32.

(ii) qualitative and quantitative information about exposure to risks arising from financial instruments.

Qualitative disclosures describe the undertaking’s objectives, policies and processes for managing those risks.

The quantitative disclosures attempt to quantify risk and may be based on internal reports.

Much of the material of IFRS 7 is based on the bank supervisory regulations of the Bank for International Settlements (Basel 2): www.bis.org/ which apply to international banks in the countries that have adopted Basel 2.

There are a number of differences. For example, Basel 2 requires reporting on operational risk, which is nor required by IFRS 7. Also, some definitions vary. The two systems are likely to converge over the next few years.

Objective of IFRS 7

The objective is that disclosures in the financial statements should enable users to evaluate:

(i) the importance of financial instruments for the undertaking’s financial position and performance; and

(ii) the nature and extent of risks arising from financial instruments, and how the risks are managed.



http://www.bis.org/


The principles in IFRS 7 complement those in IAS 32, IAS 39 and IFRS 9.

IAS 1 Presentation of Financial Statements Update (2007)

IFRS 7 is based on IAS 1 for the presentation of financial statements.

IAS 1 was updated in 2007. The changes are listed in the IAS 1 workbook. One of the changes is the retitling of the balance sheet as the statement of financial position.

The Board decided to rename a new statement a ‘statement of comprehensive income’. The term ‘comprehensive income’ is not defined in the Framework but is used in IAS 1 to describe the change in equity of an undertaking during a period from transactions, events and circumstances other than those resulting from transactions with owners in their capacity as owners.

Although the term ‘comprehensive income’ is used to describe the aggregate of all components of comprehensive income, including profit or loss, the term ‘other comprehensive income’ refers to income and expenses that under IFRSs are included in comprehensive income but excluded from profit or loss (such as revaluations of available-for-sale financial instruments, which previously were accounted for directly in equity).

The Board decided that an undertaking should have the choice of presenting all income and expenses recognised in a period in one statement or in two statements. The Board acknowledged that the titles ‘income statement’ and ‘statement of profit or loss’ are similar in meaning and

could be used interchangeably, and decided to retain the title ‘income statement’ as this is more commonly used.

This workbook has not been updated with the new titles of the statements, as most readers will be more familiar with the previous titles and foreign translations (especially into Russian) have yet to be agreed.

We recommend that readers review the section of IAS 1 workbook covering a ‘statement of comprehensive income’, as this will cause presentation changes regardless of when (or whether) the new titles of statements are adopted by users.

Scope

IFRS 7 applies to recognised and unrecognised financial instruments.

Recognised financial instruments include financial assets and financial liabilities that are within the scope of IFRS9.

Unrecognised financial instruments include some financial instruments that are outside the scope of IFRS 9, such as some loan commitments.

IFRS 7 applies to contracts to buy or sell a non-financial item that are within the scope of IFRS 9.

Exceptions to IFRS 7:(i) interests in subsidiaries, associates and joint ventures (though IFRS 7 applies to those accounted for under IFRS 9)




and to all derivatives linked to these interests, unless the derivative is an equity instrument.

(ii) employers’ rights and obligations arising from employee benefit plans, to which IAS 19 applies.

(iii) insurance contracts as defined in IFRS 4 (though IFRS 7 applies to derivatives that are embedded in insurance contracts if IFRS 9 requires them to be accounted for separately).

(iv) financial instruments, contracts and obligations under share-based payment transactions to which IFRS 2 applies (though IFRS 7 applies to those within the scope of IFRS 9).

Classes of financial instruments and level of disclosure

An undertaking shall group financial instruments into classes that are suitable to the nature of the information disclosed and the characteristics of those financial instruments.

An undertaking shall provide adequate information to enable reconciliation to the line items presented in the balance sheet. The classes are determined by the undertaking and are distinct from the categories of financial instruments specified in IFRS 9 (which determine how financial instruments are measured and where changes in fair value are recognised).

In determining classes of financial instrument, an undertaking shall:

(i) distinguish instruments measured at amortised cost from those measured at fair value.

(ii) treat as a separate class, or classes, those financial instruments outside the scope of IFRS 7.

An undertaking decides how much detail it provides to satisfy the requirements of IFRS 7, how much emphasis it places on different aspects of the requirements and how it aggregates information to display the overall picture without combining information with different characteristics.

Classes of financial instruments

IFRS 7 requires certain disclosures to be given by class of financial instrument, for example, the reconciliation of an allowance account.

IFRS 7 does not provide a prescriptive list of classes of financial instruments. It states that a class should contain financial instruments of the same nature and characteristics and that the classes should be reconciled to the line items presented in the balance sheet.

What considerations should an undertaking apply in identifying different classes of financial instruments since a prescriptive list of classes is not provided?

For example, should a bank disclose .loans and advances as a single class, or should it be split further into separate classes?

A class of financial instruments is not the same as a category of financial instruments. Categories are defined in IFRS 9 as financial




assets at fair value through profit or loss, held-to-maturity investments, loans and receivables, available-for-sale financial assets, financial liabilities at fair value through profit or loss and financial liabilities measured at amortised cost.

Classes are expected to be determined at a lower level than the measurement categories in IFRS 9 and reconciled back to the balance sheet, as required by IFRS 7.

However, the level of detail for a class should be determined on an undertaking-specific basis. In the case of banks, the category loans and advances is expected to comprise more than one class unless

the loans have similar characteristics. It may be appropriate to provide separate classes by:

-types of customers: for example, commercial loans and loans to individuals; or- types of loans: for example, mortgages, credit cards, unsecured loans and overdrafts.

In some cases, loans to clients can be one class if all the loans have similar characteristics (eg, a saving bank providing only one type of loan to individuals).




The possible classes within the categories of the commercial bank’s financial assets and financial liabilities are presented below.




Categories (in accordance with IAS 39) Classes

Financial assets

Financial assets designated at fair value through profit or loss

Assets held for trading Debt securitiesEquity securities

Derivative financial instruments


Debt securitiesEquity securities

Loans and advances

Deposits at other banks

Loans and advances to customers

Loans to individual (retail) borrowers

Credit cardsAuto loansMortgagesOther assets

Loans and advances to corporate undertakings

Large corporate undertakingsMedium and small-scale business Others

Held-to-maturity investments Debt securities Listed

Unlisted

Available for sale equity investments

Debt securities Listed Unlisted

Equity securities Listed Unlisted

Financial liabilities Financial liabilities designated at fair value through profit or loss

Trading liabilities Derivative financial instrumentsFinancial liabilities designated at fair value through profit or loss

Debt securities in issue




Categories (in accordance with IAS 39) Classes

Financial liabilities measured at amortised cost

Due from other banks

Due to customers Personal customersLarge corporate undertakingsMedium and small-scale business

Debt securities in issueSubordinated deposits Other borrowed funds

Categories of liabilities are unchanged under IFRS 9. Asset categories, except the first, will change under IFRS 9. Please see the IFRS 9 workbook.Examples of classes will still be usable under IFRS 9.




Importance of financial instruments for financial position and performance

An undertaking shall disclose information that enables users to evaluate the importance of financial instruments for its financial

position (balance sheet) and performance (profit and loss account).

Balance sheet (SFP)

Categories of financial assets and financial liabilitiesThe carrying amounts of each of the following categories, as defined in IAS 39, shall be disclosed either on the face of the balance sheet or in the notes:

(i) financial assets at fair value through profit or loss, showing separately those designated as such upon initial recognition and those classified as held for trading;

(ii) held-to-maturity investments;

(iii) loans and receivables;

(iv) available-for-sale financial assets;

(v) financial liabilities at fair value through profit or loss, showing separately (1) those designated as such upon initial recognition and (2) those classified as held for trading; and

(vi) financial liabilities measured at amortised cost.


Strategy in using financial instruments –Text example from Illustrated Consolidated Financial Statements 2004- Banks PwC

By their nature, the Group’s activities are principally related to the use of financial instruments including derivatives. The Group accepts deposits from customers at both fixed and floating rates, and for various periods, and seeks to earn above-average interest margins by investing these funds in high-quality assets. The Group seeks to increase these margins by consolidating short-term funds and lending for longer periods at higher rates, while maintaining sufficient liquidity to meet all claims that might fall due.

The Group also seeks to raise its interest margins by obtaining above-average margins, net of allowances, through lending to commercial and retail borrowers with a range of credit standing. Such exposures involve not just on-balance sheet loans and advances; the Group also enters into guarantees and other commitments such as letters of credit and performance, and other bonds.

The Group also trades in financial instruments where it takes positions in traded and over-the-counter instruments, including derivatives, to take advantage of short-term market movements in equities and bonds and in currency, interest rate and commodity prices.

The Board places trading limits on the level of exposure that can be taken in relation to both overnight and intra-day market positions. With the exception of specific hedging arrangements, foreign exchange and interest rate exposures associated with these derivatives are normally offset by entering into counterbalancing positions, thereby controlling the variability in the net cash amounts required to liquidate market positions.



Example of Balance Sheet Assets (Extract from FINREP table 1.1)

Amounts

Cash and cash balances with central banksFinancial assets held for trading

Derivatives held for trading Equity instrumentsDebt instrumentsLoans and advances


Equity instruments Debt instruments Loans and advances

Available-for-sale financial assetsEquity instrumentsDebt instruments Loans and advances

Loans and receivables (including finance leases)

Debt instrumentsLoans and advances

Held-to-maturity investments Debt instruments Loans and advances

Derivatives – Hedge accounting Fair value hedgesCash flow hedgesHedges of a net investment in a foreign

operationFair value hedge of interest rate riskCash flow hedge interest rate risk

Fair value changes of the hedged items in portfolio hedge of interest rate risk

Example of Balance Sheet Liabilities(Extract from FINREP table 1.2)

Amounts

Deposits from central banks

Financial liabilities held for trading

Derivatives held for tradingShort positions Deposits from credit institutionsDeposits (other than from credit

institutions)Debt certificates (including bonds

intended for repurchase in short term)Other financial liabilities held for trading

Financial liabilities designated at fair value through profit or loss

Deposits from credit institutionsDeposits (other than from credit

institutions)Debt certificates (including bonds)Subordinated liabilitiesOther financial liabilities designated at

fair value through profit or lossFinancial liabilities measured at amortised cost

Deposits from credit institutionsDeposits (other than from credit

institutions) Debt certificates ( including bonds)Subordinated liabilitiesOther financial liabilities measured at

amortised costFinancial liabilities associated with transferred financial assetsDerivatives – Hedge accounting

Fair value hedges

Cash flow hedges

Hedges of a net investment in a foreign operation

Fair value hedge of interest rate risk




Cash flow hedge interest rate riskFair value changes of the hedged items in portfolio hedge of interest rate risk

(Note: The copyright of FINREP belongs to the European Banking Authority: www.eba.europa.eu/Home.aspx The complete copy of FINREP is attached to this workbook.)

Financial assets or financial liabilities at fair value through profit or loss

In the following examples, I/B refers to Income Statement and Balance Sheet (SFP).

EXAMPLE fair value through profit and loss You hold a fixed-rate interest bond for trading purposes that yields 10% interest per year. National interest rates fall from 7%, when you bought it, to 5% at the reporting date. The market value of the bond has increased by 43. This increase in fair value is recorded in the Income Statement even though the profit has yet to be realized.

I/B DR CRFair value through profit and loss – debt instruments

B 43

Interest Income- fair value through profit and loss financial assets

I 43

Revaluation of available for sale debt instruments

If the undertaking has recorded loans or receivables at fair value through profit or loss, it shall disclose: (i) the maximum exposure of the loans or receivables to credit risk at the reporting date.

(ii) the amount by which any related credit derivatives or similar instruments reduce that maximum exposure to credit risk.

(iii) the change, during the period and cumulatively, in the fair value of the loans or receivables that is attributable to changes in the credit risk of the financial asset calculated either:

(1) as the change in its fair value that is not attributable to changes in market conditions that give rise to market risk; or

(2) by using an alternative method that better represents the change in its fair value that is attributable to changes in the credit risk of the asset.

Changes in market conditions giving rise to market risk include changes in a benchmark interest rate, commodity price, foreign exchange rate or indices of prices or rates.

(iv) the change in the fair value of any related credit derivatives or similar instruments that has occurred during the period and cumulatively since the loan or receivable was designated.




If the undertaking has recorded a financial liability as at fair value through profit or loss, it shall disclose:


Financial assets at fair value through profit or loss (including trading) –Example from Illustrated Consolidated Financial Statements 2004- Banks PwC

2XX4 2XX3

TradingGovernment bonds included in cash equivalents (Note 41) 1,949 2,676Other government bonds 1,180 945Other debt securities 885 3,402

Equity securities:– listed 1,083 1,080– unlisted 134 101

Total trading 5,231 8,204

Financial assets at fair value through profit or loss (at initial recognition) 2,520 1,102

Total 7,751 9,306

Securities pledged under repurchase agreements with other banks are government bonds with a market value at 31 December 2XX4 of €939 (2XX3: €1,041). Other non-government bonds are also pledged under repurchase agreements with a market value of €31 (2XX3: €23). These are separately reclassified as pledged assets on the face of the balance sheet. All repurchase agreements mature within 12 months.

Included in financial assets at fair value through profit or loss are primarily convertible bonds that would otherwise have been classified as available for sale with the embedded conversion option separately accounted for.

In 31 December 2XX3 financial statements, financial assets at fair value through profit or loss were classified as originated loans and receivables and had a carrying amount of €982. A fair value gain of €20 was recognised in opening retained earnings due to this reclassification.



(i) the change, during the period and cumulatively, in the fair value of the financial liability that is attributable to changes in the credit risk of that liability calculated either:

(1) as the change in its fair value that is not attributable to changes in market conditions that give rise to market risk; or

(2) using an alternative method the undertaking believes better represents the amount of change in its fair value that is attributable to changes in the credit risk of the liability.

Changes in market conditions that give rise to market risk include changes in a benchmark interest rate, the price of another undertaking’s financial instrument, a commodity price, a foreign exchange rate or indices of prices or rates.

(ii) the difference between the financial liability’s carrying amount and the amount the undertaking would be contractually required to pay at maturity.

The undertaking shall disclose:

(i) the methods used to comply with the above requirements.

(ii) if the disclosure does not faithfully represent the change in the fair value of the financial asset or financial liability attributable to changes in its credit risk, the reasons for reaching this conclusion.

Reclassification

If the undertaking has reclassified a financial asset as one measured:

(i) at cost or amortised cost, rather than at fair value; or(ii) at fair value, rather than at cost or amortised cost, it shall disclose the amount reclassified into and out of each category, and the reason for that reclassification.

(Please see example in the last paragraph of the box above.)

Derecognition

An undertaking may have transferred (“sold”) financial assets in such a way that part or all of the financial assets do not qualify for derecognition (removal from the balance sheet). The undertaking shall disclose for each class of such financial assets:

Derecognition-continuing involvement – Example from Illustrated Consolidated Financial Statements 2004- Banks PwC Note – Loans and advances to customers

During the year, the Group transferred to a third party the right to any collections of principal and 7.5% interest on €900 out of a portfolio of €1,000 AA-rated loans.

The Group retains the right to €100 of any collection of principal plus interest thereon of 8%, plus the excess spread of 0.5% on the remaining €900 of principal, and any prepayments are allocated proportionally. Any defaults on the €1,000 are first deducted from the Group’s interest of €100 until that interest is exhausted.




The Group has transferred some significant risks and rewards (for example, prepayment risk) and has also retained some significant risks and rewards (for example, through the subordinated interest). The Group continues to recognise the asset to the extent of its continuing involvement.

The total amount of the asset is €204, of which €104 represents the Group’s additional continuing involvement from the subordination of its retained interest for credit losses and the excess spread. A liability with a carrying amount of €106.50 has also been recognised.

(i) the nature of the assets;

(ii) the nature of the risks and rewards to which it remains exposed;(iii) when the undertaking continues to recognise all of the assets, the carrying amounts of the assets and of the associated liabilities; and

(iv) when the undertaking continues to recognise the assets to the extent of its continuing involvement, the total carrying amount of the original assets, the amount of the assets that the undertaking continues to recognise, and the carrying amount of the associated liabilities.

FINREP table 17 illustrates an example of Derecognition and financial liabilities associated with transferred financial assets.

Collateral

An undertaking shall disclose:

(i) the carrying amount of financial assets it has pledged as collateral for liabilities or contingent liabilities; and

(ii) the conditions relating to its pledge.

When an undertaking holds collateral (of financial or non-financial assets) and is allowed to sell or repledge the collateral without default by the owner of the collateral, it shall disclose:

(i) the fair value of the collateral held;

(ii) the fair value of any such collateral sold or repledged, and whether the undertaking has an obligation to return it; and

(iii) the conditions associated with its use of the collateral.

Derecognition-continuing involvement – Example from Illustrated Consolidated Financial Statements 2004- Banks PwCNote – Loans and advances to customers

During the year, the Group transferred to a third party the right to any collections of principal and 7.5% interest on €900 out of a portfolio of €1,000 AA-rated loans.

The Group retains the right to €100 of any collection of principal plus interest thereon of 8%, plus the excess spread of 0.5% on the remaining €900 of principal, and any prepayments are allocated




proportionally. Any defaults on the €1,000 are first deducted from the Group’s interest of €100 until that interest is exhausted.

The Group has transferred some significant risks and rewards (for example, prepayment risk) and has also retained some significant risks and rewards (for example, through the subordinated interest). The Group continues to recognise the asset to the extent of its continuing involvement.

The total amount of the asset is €204, of which €104 represents the Group’s additional continuing involvement from the subordination of its retained interest for credit losses and the excess spread. A liability with a carrying amount of €106.50 has also been recognised.

Example of Collateral held - FINREP table D - adapted(When permitted to sell or repledge the collateral in the absence of default by the owner of collateral)

Fair values of collateral held Fair values of collateral

sold/repledgedFinancial assets

Equity instruments Debt instruments Loans & advances

Non-financial assets Property, plant & equipment Investment property Other

Conditions associated with the use of the collateral

EXAMPLE Collateral permitted to sellhttp://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 24



I/B DR CRCash received from sale of collateral

B 400

Client’s loan account B 400Sale of part of client’s investment property pledged as collateral

Example of Collateral obtained by taking possession during the period – FINREP table E AmountNon-current assets held-for-saleProperty, plant and equipmentInvestment propertyEquity and debt instrumentsCashOtherTotal

EXAMPLE Collateral obtained by possessionYour client owes you 3500. The loan was unsecured, but you now have a charge over some shares worth 3000 as collateral. These would not be recorded in the balance sheet, but noted in the table (E) above.If the client defaults, and you sell the shares for their fair value, the entries would be:

I/B DR CRCash received from sale of collateral

B 3000

Bad debt expense I 500Client’s loan account B 3500Sale of client’s shares pledged as collateral and recognition of a bad debt

Allowance account for credit losses

When financial assets are impaired by credit losses and the undertaking records the impairment in a separate account (or accounts) rather than directly reducing the carrying amount of the asset, it shall disclose a reconciliation of changes in that account (those accounts) during the period for each class of financial assets.

Compound financial instruments with multiple-embedded derivatives

If an undertaking has issued an instrument that contains both a liability and an equity component and the instrument has multiple-embedded derivatives whose values are interdependent (such as a callable convertible debt instrument), it shall disclose the existence of those features.A callable convertible debt instrument is a loan issued by the undertaking that can be converted into equity under specified conditions at specified times.

The company may instruct (“call”) the holder to make the conversion. There is a value to the loan and an additional value for its convertibility. It the value of the equity falls, the value of the loan falls as the company can force the holder to exchange the debt for the lower value of equity.




Defaults and breaches

For loans payable (owed by the undertaking) recognised at the reporting date, an undertaking shall disclose:

(i) details of any defaults during the period of principal, interest, sinking fund, or redemption terms of those loans payable;

(ii) the carrying amount of the loans payable in default at the reporting date; and

(iii) whether the default was remedied, or the terms of the loans payable were renegotiated, before the financial statements were authorised for issue.

During the period, if there were breaches of other loan agreements an undertaking shall disclose the same information if those breaches enabled the lender to demand accelerated repayment (unless the breaches were remedied, or the terms of the loan were renegotiated, on or before the reporting date).

Profit and Loss Account and Equity

(FINREP tables 2 and 21 provide examples of a consolidated income statement and Example of Note on Realised gains (losses) on financial assets and liabilities not measured at fair value through profit or loss,)

Items of income, expense, gains or losses

An undertaking shall disclose the following items of income, expense, gains or losses either on the face of the financial statements or in the notes:

(i) total interest income and total interest expense (calculated using the effective interest method) for financial assets or financial liabilities that are not at fair value through profit or loss;


Default note (no defaults) – Example from Illustrated Consolidated Financial Statements 2004- Banks PwC

The Group has not had any defaults of principal, interest or redemption amounts during the period on its borrowed funds (2XX3: nil)

The Group has not had any defaults of principal, interest or other breaches with respect to their liabilities during the period (2XX3: nil).



EXAMPLE effective interest methodYou buy a bond with a face value of 100. It is paying a higher rate of interest than other bonds and you buy it for 116. The premium of 16 is capitalised and amortised over the period of the bond. It reduces the interest received in each period.

I/B DR CRBond purchased B 100Bond premium B 16Cash paid B 116Purchase of bondInterest received I 2Bond premium (amortisation) B 2Amortisation of bond premium in period 1 = reduction of interest received.

Interest and dividends on financial instruments

Undertaking A is applying IFRS 7 and is considering the presentation of interest income, interest expense and dividend income on financial instruments at fair value through profit or loss.

Should these items of income and expense be reported as part of net gains or net losses on these financial instruments or disclosed separately as part of interest income, interest expense or dividend income?

IFRS 7 allows an accounting policy choice between these two treatments. Undertaking A should apply its chosen policy consistently and disclose the policy adopted.

Interest income is the charge for the use of cash or cash equivalents or amounts due to the undertaking under IAS 18.

Dividend income is the distribution of profits to holders of equity investments in proportion to their holdings of a particular class of capital.

The nature of dividend income is therefore different from interest income and it is possible to adopt one treatment for interest income and interest expense and a different treatment for dividend income.

However, the reporting of interest income should be consistent with that of interest expense.

IAS 18 requires undertakings to disclose the amount of dividend income, if significant. Therefore, if undertaking A reports dividend income from equity investments as part of net gains or net losses on financial instruments at fair value through profit or loss (FVTPL), the amount of dividend income on financial assets at FVPTL should be disclosed in the notes.

(ii) fee income and expense (other than amounts included in determining the effective interest rate) arising from:

(i) financial assets or financial liabilities that are not at fair value through profit or loss; and

(ii) trust and other fiduciary activities that result in the holding or investing of assets on behalf of others;

EXAMPLE trust and other fiduciary activitiesYou manage some investment folios for clients and receive 48 as a management fee.




I/B DR CRCash Received B 48Fee income – fiduciary activities I 48Fee income – fiduciary activities

(iii) interest income on impaired financial assets; and

(iv) the amount of any impairment loss for each class of financial asset.

EXAMPLE impairment lossAt the end of the period, you revalue your financial assets and find that your equity instruments (shares) that are for trading have fallen in value by 80.

I/B DR CRLoss on Equity Instruments held for trading

I 80

Held for trading – equity instruments

B 80

Revaluation of financial assetsequity instruments

Gains and Losses –general rules (excluding hedged instruments)

A gain or loss arising from a change in the fair value of a financial asset or financial liability is recorded, as follows.

(i) A gain or loss on a financial asset or financial liability classified as at fair value through profit or loss shall be recorded in profit or loss.

(ii) A gain or loss on an available-for-sale financial asset shall be recorded directly in equity, through the statement of changes in equity, except for impairment losses and foreign exchange gains and losses, until the financial asset is derecognised, at which time the cumulative gain or loss previously recorded in equity shall be recorded in profit or loss.

Interest calculated using the effective interest method is recorded in profit or loss.

Dividends on an available-for-sale equity instrument are recorded in profit or loss, when receivable.

For financial assets and financial liabilities carried at amortised cost, a gain or loss is recorded in profit or loss when the financial asset or financial liability is derecognised or impaired, and through the amortisation process.

(v) net gains or net losses on:

(i) financial assets or financial liabilities at fair value through profit or loss, showing separately those on financial assets or financial liabilities recorded as such upon initial recognition, and those on financial assets or financial liabilities that are held for trading;

(ii) available-for-sale financial assets, showing separately the amount of gain or loss recognised directly in equity during the period and the amount removed from equity and recognised in profit or loss for the period;




EXAMPLE net gains or net losses on available-for-sale financial assetsAt the end of the period, you revalue your available-for-sale financial assets and find that your bonds that are available for sale have fallen in value by 60, but there is a foreign exchange gain of 14 relating to them.

I/B DR CRAvailable for Sale-Bonds B 46Loss on Available for Sale-Bonds I 60Exchange gain on Available for Sale-Bonds

I 14

Revaluation of available-for-sale financial assets - bonds

(iii) held-to-maturity investments;

(iv) loans and receivables; and

(v) financial liabilities measured at amortised cost;

IFRS 7 for a first-time adopter

Undertaking A will transition to IFRS from its previous GAAP for the year ending 31 December 2007. It will present two years of comparative information so its date of transition will be 1 January 2005.

IFRS 7 is applicable for annual periods beginning on or after1 January 2007 and so undertaking A will need to apply IFRS 7 to its first IFRS financial statements.

IFRS 1, First Time Adoption of IFRS, provides relief for companies that adopt IFRS before 1 January 2006.This relief exempts a first-

time adopter from presenting the comparative disclosures required by IFRS 7 in its first IFRS financial statements.

Can A apply the exemption and not provide the IFRS 7 disclosures for 2005 or 2006?

No, undertaking A must provide IFRS 7 disclosures for all periods presented, including 2005 and 2006. The exemption only applies to first-time adopters whose date of adoption is before 1 January 2006 and who choose to early adopt IFRS 7. Undertaking

A’s date of adoption of IFRS is 1 January 2007. It therefore does not qualify for the exemption.

IFRS 7 and interim reporting

Undertaking B is applying IFRS 7 for the first time from 1 January 2007.

Management is preparing its condensed interim financial report for the period ending 30 June 2007 in accordance with IAS 34, Interim Financial Reporting.

Should B apply IFRS 7 in the interim financial statements for the period ending 30 June 2007?

IFRS 7 is a disclosure standard rather than a measurement standard. IAS 34 requires the interim report to be prepared using the same policies as will be used for the next annual financial statements, and that any changes to the policies are explained in the notes.

Adopting IFRS 7 will not affect the amounts reported in the primary http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 29



statements and will not cause a change to the interim reporting where a condensed interim report is presented.

However, IAS 34 requires that an explanation of events and transactions is given where an understanding of these is significant to understanding the current interim period.

When identifying the disclosures necessary to explain such an event or transaction, consideration should be given to the IFRS 7 disclosures that might be required for that event or transaction in the annual financial statements.

However, an undertaking that includes a complete set of financial statements in its interim report, rather than condensed financial information, should present all ofthe disclosures required by IFRS 7, including full comparative information.

Other disclosures

Accounting policies

An undertaking discloses, in the summary of important accounting policies, the measurement bases used in preparing the financial statements and the other accounting policies used that are relevant to understanding the financial statements (IAS 1).

IAS 1 also requires undertakings to disclose, in the summary of important accounting policies or other notes, the judgements, apart from those involving estimates, that management has made in the process of applying the undertaking’s accounting

policies and that have the most material impact on the amounts recognised in the financial statements.Critical accounting estimates, and judgements in applying accounting policies - Example from Illustrated Consolidated Financial Statements 2004- Banks PwC

The Group makes estimates and assumptions that affect the reported amounts of assets and liabilities within the next financial year. Estimates and judgements are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances.

(i) Impairment losses on loans and advancesThe Group reviews its loan portfolios to assess impairment at least on a quarterly basis. In determining whether an impairment loss should be recorded in the income statement, the Group makes judgements as to whether there is any observable data indicating that there is a measurable decrease in the estimated future cash flows from a portfolio of loans before the decrease can be identified with an individual loan in that portfolio.

This evidence may include observable data indicating that there has been an adverse change in the payment status of borrowers in a group, or national or local economic conditions that correlate with defaults on assets in the group.

Management uses estimates based on historical loss experience for assets with credit risk characteristics and objective evidence of impairment similar to those in the portfolio when scheduling its future cash flows. The methodology and assumptions used for estimating both the amount and timing of




future cash flows are reviewed regularly to reduce any differences between loss estimates and actual loss experience. To the extent that the net present value of estimated cash flows differs by +/-5 percent, the provision would be estimated €8 higher or €5 lower.

(ii) Fair value of derivativesThe fair value of financial instruments that are not quoted in active markets are determined by using valuation techniques. Where valuation techniques (for example, models) are used to determine fair values, they are validated and periodically reviewed by qualified personnel independent of the area that created them.

All models are certified before they are used, and models are calibrated to ensure that outputs reflect actual data and comparative market prices. To the extent practical, models use only observable data, however areas such as credit risk (both own and counterparty), volatilities and correlations require management to make estimates. Changes in assumptions about these factors could affect reported fair value of financial instruments. For example, to the extent that management used a tightening of 20 basis points in the credit spread, the fair values would be estimated at €1,553 as compared to their reported fair value of €1,548 at the balance sheet date.

(iii) Impairment of available for-sale equity investmentsThe Group determines that available-for-sale equity investments are impaired when there has been a significant or prolonged decline in the fair value below its cost.

This determination of what is significant or prolonged requires judgement. In making this judgement, the Group evaluates

among other factors, the normal volatility in share price. In addition, impairment may be appropriate when there is evidence of a deterioration in the financial health of the investee, industry and sector performance, changes in technology, and operational and financing cash flows.

Had all the declines in fair value below cost been considered significant or prolonged, the Group would suffer an additional €105 loss in its 2004 financial statements, being the transfer of the total fair value reserve to the income statement.

(iv) Held-to-maturity investmentsThe Group follows the guidance of IAS 39 on classifying non-derivative financial assets with fixed or determinable payments and fixed maturity as held-to-maturity.

This classification requires significant judgement. In making this judgement, the Group evaluates its intention and ability to hold such investments to maturity. If the Group fails to keep these investments to maturity other than for the specific circumstances – for example, selling an insignificant amount close to maturity – it will be required to reclassify the entire class as available-for-sale.

The investments would therefore be measured at fair value not amortised cost. If the entire class of held-to-maturity investments is tainted, the fair value would increase by €62m, with a corresponding entry in the fair value reserve in shareholders’ equity.(End of example)




Hedge accounting (Please also see our workbook on hedging – part of the IAS 32/39 set of workbooks.)

Matching assets and liabilities that will be liquidated at the same time eliminates timing differences and liquidity risk. Hedging is a partial matching of financial assets and liabilities as an insurance policy against an unprofitable rise, or fall, in either instrument.

Fair value hedges recognise that financial instruments with fixed rates of interest will gain or lose value if national interest rates change (as they will be worth more or less due to the change).

Cash flow hedges match assets with liabilities in the same currency at the time of their liquidation. Typically, this would involve financing a loan to a client by borrowing the same amount, for the same length of time, in the same currency from another lender. The rate paid by the client would be higher than that paid to the lender, the difference being the bank’s profit.

Hedges of net investments in foreign operations relate to the risk of the value of foreign subsidiaries, subsidiaries and joint ventures losing value when the local currency falls against that of the holding company. The hedge normally involves financing all or part of the foreign operations by a loan (liability) in its local currency.

Hedge accounting seeks to match the hedged asset and liability (including derivatives) so that their impact on the income statement is simultaneous. If their total impact will arise in the same period, no hedge accounting is necessary. If not, any changes in the value of

hedged assets and liabilities is deferred by recording it in equity until the entire hedge is liquidated.

An undertaking shall disclose the following separately for each type of hedge (fair value hedges, cash flow hedges, and hedges of net investments in foreign operations): (i) a description of each type of hedge;

(ii) a description of the financial instruments recorded as hedging instruments and their fair values at the reporting date; and

(iii) the nature of the risks being hedged.

For cash flow hedges, an undertaking shall disclose:

(i) the periods when the cash flows are likely to occur and when they are expected to impact profit or loss;

(ii) a description of any forecast transaction for which hedge accounting had previously been used, but which is no longer likely to occur;

(iii) the amount that was recognised in equity during the period;

(iv) the amount that was removed from equity and included in profit or loss for the period, showing the amount included in each line item in the income statement; and

(v) the amount that was removed from equity during the period and included in the original cost or other carrying amount of a non-financial asset or non-financial liability whose




acquisition or incurrence was a hedged highly-probable forecast transaction.

An undertaking shall disclose separately:

(i) in fair value hedges, gains or losses:

(1) on the hedging instrument; and

(2) on the hedged item attributable to the hedged risk.

(ii) the ineffectiveness recognised in profit or loss that arises from cash flow hedges; and

(iv) the ineffectiveness recognised in profit or loss that arises from hedges of net investments in foreign operations.

(FINREP table A presents an example of a note covering Derivatives used in Hedge Accounting.)

Hedge note – Example from Illustrated Consolidated Financial Statements 2004- Banks PwC

The Group documents, at the inception of the transaction, the relationship between hedginginstruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. The Group also documents its assessment, both at hedge inception and on an ongoing basis, of whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items.

(i) Fair value hedgeChanges in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with any changes in the fair value of the hedged asset or liability that are attributable to the hedged risk.

If the hedge no longer meets the criteria for hedge accounting, the adjustment to the carrying amount of a hedged item for which the effective interest method is used is amortised to profit or loss over the period to maturity. The adjustment to the carrying amount of a hedged equity security remains in retained earnings until the disposal of the equity security.

(ii) Cash flow hedgeThe effective portion of changes in the fair value of derivatives that are designated and qualify as cashflow hedges are recognised in equity. The gain or loss relating to the ineffective portion is recognised immediately in the income statement.

Amounts accumulated in equity are recycled to the income statement in the periods in which the hedged item will affect profit or loss (for example, when the forecast sale that is hedged takes place).

When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss existing in equity at that time remains in equity and is recognised when the forecast transaction is ultimately recognised in the income statement. When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was reported in equity is immediately transferred to the income statement.




(iii) Net investment hedgeHedges of net investments in foreign operations are accounted for similarly to cash flow hedges. Any gain or loss on the hedging instrument relating to the effective portion of the hedge is recognised in equity; the gain or loss relating to the ineffective portion is recognised immediately in the income statement. Gains and losses accumulated in equity are included in the income statement when the foreign operation is disposed of.

(iv) Derivatives that do not qualify for hedge accounting Certain derivative instruments do not qualify for hedge accounting. Changes in the fair value of any derivative instrument that does not qualify for hedge accounting are recognised immediately in the income statement.

Such disclosure may include:

(i) for financial assets or financial liabilities recorded as at fair value through profit or loss:

(1) the nature of the financial assets or financial liabilities the undertaking has recorded as at fair value through profit or loss;

(2) the criteria for so recording such financial assets or financial liabilities on initial recognition; and

Classification of investments at initial recognition note – Example from Illustrated Consolidated Financial Statements 2004- Banks PwC

The Group classifies its financial assets in the

following categories: financial assets at fair value through profit or loss; loans and receivables; held-to-maturity investments; and available-for-sale financial assets. Management determines the classification of its investments at initial recognition.

(i) Financial assets at fair value through profit or lossThis category has two sub-categories: financial assets held for trading, and those designated at fair value through profit or loss at inception. A financial asset is classified in this category if acquired principally for the purpose of selling in the short term or if so designated by management. Derivatives are also categorised as held for trading unless they are designated as hedges.

(ii) Loans and receivablesLoans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. They arise when the Group provides money, goods or services directly to a debtor with no intention of trading the receivable.

(iii) Held-to-maturityHeld-to-maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturities that the Group’s management has the positive intention and ability to hold to maturity. Were the Group to sell other than an insignificant amount of held-to-maturity assets, the entire category would be tainted and reclassified as available for sale.

(iv) Available-for-saleAvailable-for-sale investments are those intended to




be held for an indefinite period of time, which may be sold in response to needs for liquidity or changes in interest rates, exchange rates or equity prices.

Purchases and sales of financial assets at fair value through profit or loss, held to maturity and available for sale are recognised on trade-date – the date on which the Group commits to purchase or sell the asset. Loans are recognised when cash is advanced to the borrowers. Financial assets are initially recognised at fair value plus transaction costs for all financial assets not carried at fair value through profit or loss. Financial assets are derecognised when the rights to receive cash flows from the financial assets have expired or where the Group has transferred substantially all risks and rewards of ownership.

(3) how the undertaking has satisfied the conditions in IFRS 9 for such designation. That disclosure includes a description of the circumstances underlying the measurement or recognition inconsistency that would otherwise arise. That disclosure includes a description of how recording at fair value through profit or loss is consistent with the undertaking’s documented risk management or investment strategy.

(ii) the criteria for recording financial assets as available for sale.

Available for sale assets is the default group for any financial instruments that have not been designated as belonging to one of the other three categories. As the example note above illustrates, they may be either sold when the need arises, or kept indefinitely.

(iii) whether regular way purchases and sales of financial assets are accounted for at trade date or at settlement date.

A regular way purchase (or sale) is a purchase (or sale) of a financial asset under a contract whose terms require delivery of the asset within the times established by regulation or convention in the marketplace concerned. IFRS allows a choice of accounting between the date of the agreement (the trade date) and the settlement date, when the payment for the financial instrument is made, which may be a few days later than the trade date. Having made this choice of accounting date, it must be consistently applied.

(iv) when an allowance account is used to reduce the carrying amount of financial assets impaired by credit losses:

From the Impairment of financial assets note below: “If there is objective evidence that an impairment loss on loans and receivables or held-to-maturity investments carried at amortised cost has been incurred, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows (excluding future credit losses that have not been incurred) discounted at the financial asset’s original effective interest rate.

The carrying amount of the asset is reduced through the use of an allowance account and the amount of the loss is recognised in the income statement. ”

(If an allowance account is not used, then impairments will directly reduce the carrying values of the assets.)




(1) the criteria for determining when the carrying amount of impaired financial assets is reduced directly (or, in the case of a reversal of a write-down, increased directly) and when the allowance account is used; and

EXAMPLE impairment of financial assets – allowance accountAt the end of the period, you revalue your available-for-sale financial assets and find that your bonds that are available for sale have fallen in value by 80 due to credit risk. You record this in your allowance account

I/B DR CRAllowance Account - Available for Sale-Bonds

B 80

Loss on Available for Sale-Bonds I 80Impairment of available-for-sale financial assets - bonds

(2) the criteria for writing off amounts charged to the allowance account against the carrying amount of impaired financial assets.

EXAMPLE impairment of financial assets – write offUsing the previous example: At the end of the following period, you revalue your available-for-sale financial assets and find that your bonds that are available for sale have fallen in value by another 30 and are due to be redeemed. You record this in your income statement and write off amounts charged to the allowance account against the carrying amount of impaired financial assets.

I/B DR CRAllowance Account - Available for Sale-Bonds

B 80

Loss on Available for Sale-Bonds I 30Available for Sale-Bonds B 110Partial write-off of available-for-sale financial assets - bonds

(v) how net gains or net losses on each category of financial instrument are calculated, for example, whether the net gains or net losses on items at fair value through profit or loss include interest or dividend income.

How net gains or net losses on each category of financial instrument are calculated note – Example from Illustrated Consolidated Financial Statements 2004- Banks PwC

Purchases and sales of financial assets at fair value through profit or loss, held to maturity and available for sale are recognised on trade-date – the date on which the Group commits to purchase or sell the asset. Loans are recognised when cash is advanced to the borrowers.

Financial assets are initially recognised at fair value plus transaction costs for all financial assets not carried at fair value through profit or loss. Financial assets are derecognised when the rights to receive cash flows from the financial assets have expired or where the Group has transferred substantially all risks and rewards of ownership.

Purchases and sales of financial assets at fair value through profit or loss, held to maturity and available for sale are recognised on trade-date – the date on which the Group commits to purchase or sell the asset.




Loans are recognised when cash is advanced to the borrowers. Financial assets are initially recognised at fair value plus transaction costs for all financial assets not carried at fair value through profit or loss. Financial assets are derecognised when the rights to receive cash flows from the financial assets have expired or where the Group has transferred substantially all risks and rewards of ownership.

Available-for-sale financial assets and financial assets at fair value through profit or loss are subsequently carried at fair value.

Loans and receivables and held-to-maturity investments are carried at amortised cost using the effective interest method.

Gains and losses arising from changes in the fair value of the ‘financial assets at fair value through profit or loss’ category are included in the income statement in the period in which they arise.

Gains and losses arising from changes in the fair value of available-for-sale financial assets are recognised directly in equity, until the financial asset is derecognised or impaired at which time the cumulative gain or loss previously recognised in equity should be recognised in profit or loss.

However, interest calculated using the effective interest method is recognised in the income statement. Dividends on available-for-sale equity instruments are recognised in the income statement when the undertaking’s right to receive payment is established.

The fair values of quoted investments in active markets are based on current bid prices. If the market for a financial asset is not active (and for unlisted securities), the Group establishes fair value by

using valuation techniques. These include the use of recent arm’s length transactions, discounted cash flow analysis, option pricing models and other valuation techniques commonly used by market participants.

(v) the criteria used to determine that there is objective evidence that an impairment loss has occurred.

Impairment of financial assets note – Example from Illustrated Consolidated Financial Statements 2004- Banks PwC

(1) Assets carried at amortised costThe Group assesses at each balance sheet date whether there is objective evidence that a financial asset or group of financial assets is impaired.

A financial asset or a group of financial assets is impaired and impairment losses are incurred if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset (a ‘loss event’) and that loss event (or events) has an impact on the estimated future cash flows of the financial asset or group of financial assets that can be reliably estimated.

Objective evidence that a financial asset or group of assets is impaired includes observable data that comes to the attention of the Group about the following loss events:

(i) significant financial difficulty of the issuer or obligor;

(ii) a breach of contract, such as a default or delinquency in interest or principal payments;




(iii) the Group granting to the borrower, for economic or legal reasons relating to the borrower’s financial difficulty, a concession that the lender would not otherwise consider;

(iv) it becoming probable that the borrower will enter bankruptcy or other financial reorganisation;

(v) the disappearance of an active market for that financial asset because of financial difficulties; or

(vi) observable data indicating that there is a measurable decrease in the estimated future cash flows from a group of financial assets since the initial recognition of those assets, although the decrease cannot yet be identified with the individual financial assets in the group, including:– adverse changes in the payment status of borrowers in the group; or– national or local economic conditions that correlate with defaults on the assets in the group.

The Group first assesses whether objective evidence of impairment exists individually for financial assets that are individually significant, and individually or collectively for financial assets that are not individually significant.

If the Group determines that no objective evidence of impairment exists for an individually assessed financial asset, whether significant or not, it includes the asset in a group of financial assets with similar credit risk characteristics and collectively assesses them for impairment.

Assets that are individually assessed for impairment and for

which an impairment loss is or continues to be recognised are not included in a collective assessment of impairment.

If there is objective evidence that an impairment loss on loans and receivables or held-to-maturity investments carried at amortised cost has been incurred, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows (excluding future credit losses that have not been incurred) discounted at the financial asset’s original effective interest rate.

The carrying amount of the asset is reduced through the use of an allowance account and the amount of the loss is recognised in the income statement. If a loan or held-to-maturity investment has a variable interest rate, the discount rate for measuring any impairment loss is the current effective interest rate determined under the contract.

As a practical expedient, the Group may measure impairment on the basis of an instrument’s fair value using an observable market price.

The calculation of the present value of the estimated future cash flows of a collateralised financial asset reflects the cash flows that may result from foreclosure less costs for obtaining and selling the collateral, whether or not foreclosure is probable.

For the purposes of a collective evaluation of impairment, financial assets are grouped on the basis of similar credit risk characteristics (ie, on the basis of the Group’s grading process that considers asset type, industry, geographical location, collateral type, past-due status and other relevant factors).




Those characteristics are relevant to the estimation of future cash flows for groups of such assets by being indicative of the debtors’ ability to pay all amounts due according to the contractual terms of the assets being evaluated.

Future cash flows in a group of financial assets that are collectively evaluated for impairment are estimated on the basis of the contractual cash flows of the assets in the Group and historical loss experience for assets with credit risk characteristics similar to those in the Group.

Historical loss experience is adjusted on the basis of current observable data to reflect the effects of current conditions that did not affect the period on which the historical loss experience is based and to remove the effects of conditions in the historical period that do not exist currently.

Estimates of changes in future cash flows for groups of assets should reflect and be directionally consistent with changes in related observable data from period to period (for example, changes in unemployment rates, property prices, payment status, or other factors indicative of changes in the probability of losses in the group and their magnitude).

The methodology and assumptions used for estimating future cash flows are reviewed regularly by the Group to reduce any differences between loss estimates and actual loss experience.

When a loan is uncollectable, it is written off against the related provision for loan impairment. Such loans are written off after all the necessary procedures have been completed and the amount of the loss has been determined. Subsequent recoveries of amounts previously written off decrease the

amount of the provision for loan impairment in the income statement.

If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognised (such as an improvement in the debtor’s credit rating), the previously recognised impairment loss is reversed by adjusting the allowance account. The amount of the reversal is recognised in the income statement.

(2) Assets carried at fair valueThe Group assesses at each balance sheet date whether there is objective evidence that a financial asset or a group of financial assets is impaired. In the case of equity investments classified as available-for-sale, a significant or prolonged decline in the fair value of the security below its cost is considered in determining whether the assets are impaired.

If any such evidence exists for available for- sale financial assets, the cumulative loss – measured as the difference between the acquisition cost and the current fair value, less any impairment loss on that financial asset previously recognised in profit or loss – is removed from equity and recognised in the income statement.

Impairment losses recognised in the income statement on equity instruments are not reversed through the income statement. If, in a subsequent period, the fair value of a debt instrument classified as available for sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised in profit or loss, the impairment loss is reversed through the income statement.




(vii) when the terms of financial assets that would otherwise be past due or impaired have been renegotiated, the accounting policy for financial assets that are the subject of renegotiated terms.

Fair value

For each class of financial assets and financial liabilities, an undertaking shall disclose the fair value of that class of assets and liabilities reconcilable with its carrying amount. (Exceptions detailed below.)

In disclosing fair values, an undertaking shall group financial assets and financial liabilities into classes, but shall offset them only to the extent that their carrying amounts are offset in the balance sheet.


(i) the methods and, when a valuation technique is used, the assumptions applied in determining fair values of each class of financial assets or financial liabilities. For example, information about the assumptions relating to prepayment rates, rates of estimated credit losses, and interest rates or discount rates.

(ii) whether the fair values recorded or disclosed in the financial statements are determined in whole or in part using a valuation technique based on assumptions that are not supported by prices from observable current market transactions in the same instrument (that is without modification

or repackaging) and not based on available observable market data. (iii) whether the fair values recorded or disclosed in the financial statements are determined in whole or in part using a valuation technique based on assumptions that are not supported by prices from observable current market transactions in the same instrument (that is without modification or repackaging) and not based on available observable market data.

For fair values that are recorded in the financial statements, if changing one or more of those assumptions to reasonably-possible alternative assumptions would change fair value materially, the undertaking shall state this fact and disclose the impact of those changes. Materiality shall be judged with respect to profit or loss, and total assets or total liabilities, or, when changes in fair value are recognised in equity, total equity.

Materiality means that the impact on the profit or loss, total assets or total liabilities or equity would cause the report’s user to change his/her perception of the finances of the undertaking.

(iii) whether fair values are determined, in whole or in part, directly by reference to published price quotations in an active market or are estimated using a valuation technique.

(iv) if (iii) applies, the total amount of the change in fair value estimated using such a valuation technique that was recognised in profit or loss during the period.




(FINREP table 31 provides an Example of a Note regarding Information on fair value of financial instruments.)

Fair Value Hierarchy (see IFRS 13 workbook)

To make the disclosures an undertaking shall classify fair value measurements using a fair value hierarchy that reflects the significance of the inputs used in making the measurements. The fair value hierarchy shall have the following levels:

(a) quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1);

(b) inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (ie as prices) or indirectly (ie derived from prices) (Level 2); and

(c) inputs for the asset or liability that are not based on observable market data (unobservable inputs) (Level 3).

(d) The level in the fair value hierarchy within which the fair value measurement is categorised in its entirety shall be determined on the basis of the lowest level input that is significant to the fair value measurement in its entirety.

For this purpose, the significance of an input is assessed against the fair value measurement in its entirety. If a fair value measurement uses observable inputs that require significant adjustment based on unobservable inputs, that measurement is a Level 3 measurement.

Assessing the significance of a particular input to the fair value measurement in its entirety requires judgement, considering factors specific to the asset or liability.

For fair value measurements recognised in the statement of financial position, an understanding shall disclose for each class of financial instruments:

(a) the level in the fair value hierarchy into which the fair value measurements are categorised in their entirety, segregating fair value measurements.

(b) any significant transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for those transfers. Transfers into each level shall be disclosed and discussed separately from transfers out of each level. For this purpose, significance shall be judged with respect to profit or loss, and total assets or total liabilities.

(c) for fair value measurements in Level 3 of the fair value hierarchy, a reconciliation from the beginning balances to the ending balances, disclosing separately changes during the period attributable to the following:

(i) total gains or losses for the period recognised in profit or loss, and a description of where they are presented in the statement of comprehensive income or the separate income statement (if presented);

(ii) total gains or losses recognised in other comprehensive income;




(iii) purchases, sales, issues and settlements (each type of movement disclosed separately); and

(iv) transfers into or out of Level 3 (eg transfers attributable to changes in the observability of market data) and the reasons for those transfers. For significant transfers, transfers into Level 3 shall be disclosed and discussed separately from transfers out of Level 3.

(d) the amount of total gains or losses for the period in (c)(i) above included in profit or loss that are attributable to gains or losses relating to those assets and liabilities held at the end of the reporting period and a description of where those gains or losses are presented in the statement of comprehensive income or the separate income statement (if presented).

(e) for fair value measurements in Level 3, if changing one or more of the inputs to reasonably possible alternative assumptions would change fair value significantly, the entity shall state that fact and disclose the effect of those changes.

(f) The entity shall disclose how the effect of a change to a reasonably possible alternative assumption was calculated. For this purpose, significance shall be judged with respect to profit or loss, and total assets or total liabilities, or, when changes in fair value are recognised in other comprehensive income, total equity.

Disclosures of fair value are not required:

(i) when the carrying amount is a reasonable approximation of fair value, for example, short-term trade receivables and payables;

(ii) for an investment in equity instruments that do not have a quoted market price in an active market, or derivatives linked to such equity instruments, that is measured at cost (IAS 39) because its fair value cannot be measured reliably; or

(iii) for a contract containing a discretionary participation feature (IFRS 4) if the fair value of that feature cannot be measured reliably.

For (ii) and (iii), an undertaking shall disclose information to help users make their own judgements about the extent of possible differences between the carrying amount of those financial assets or financial liabilities and their fair value, including:

(i) the fact that fair value information has not been disclosed for these instruments as their fair value cannot be measured reliably;

(ii) a description of the financial instruments, their carrying amount, and why fair value cannot be measured reliably;

(iii) information about the market for the instruments;

(iv) information about whether and how the undertaking intends to dispose of the financial instruments; and

(v) if financial instruments whose fair value previously could not be reliably measured are derecognised, that fact, their carrying amount at the time of derecognition, and the amount of gain or loss recorded.




Fair values of financial assets and liabilities - Example from Illustrated Consolidated Financial Statements 2004- Banks PwC

The following table summarises the carrying amounts and fair values of those financial assets and liabilities not presented on the Group’s balance sheet at their fair value. Bid prices are used to estimate fair values of assets, whereas offer prices are applied for liabilities.

Carrying value Fair value2004 2XX3 2004 2XX3

Financial assetsDue from other banks 8,576 5,502 8,742 5,510Loans and advances to customers

59,203 53,208 59,461 53,756

Investment securities (held-to-maturity)

3,999 1,009 4,061 1,020

Financial liabilitiesDue to other banks 15,039 13,633 14,962 13,541Other deposits 16,249 12,031 16,221 11,997Due to customers 51,775 42,698 52,032 42,695Debt securities in issue 1,766 1,232 1,785 1,301Other borrowed funds 2,808 2,512 2,895 2,678

i) Due from other banksDue from other banks includes inter-bank placements and items in the course of collection.

The fair value of floating rate placements and overnight deposits is their carrying amount. The estimated fair value of fixed interest bearing deposits is based on discounted cash flows using prevailing money-market interest rates for debts with similar credit risk and remaining maturity.

ii) Loans and advances to customers




Loans and advances are net of provisions for impairment. The estimated fair value of loans and advances represents the discounted amount of estimated future cash flows expected to be received. Expected cash flows are discounted at current market rates to determine fair value.

iii) Investment securitiesInvestment securities include only interest-bearing assets held to maturity, as assets available-for-sale are measured at fair value. Fair value for held to maturity assets is based on market prices or broker/dealer price quotations. Where this information is not available, fair value has been estimated using quoted market prices for securities with similar credit, maturity and yield characteristics.

iv) Deposits and borrowings The estimated fair value of deposits with no stated maturity, which includes non-interest-bearing deposits, is the amount repayable on demand.

The estimated fair value of fixed interest-bearing deposits and other borrowings without quoted market price is based on discounted cash flows using interest rates for new debts with similar remaining maturity.

v) Debt securities in issueThe aggregate fair values are calculated based on quoted market prices. For those notes where quoted market prices are not available, a discounted cash flow model is used based on a current yield curve appropriate for the remaining term to maturity.

vi) Financial instruments measured at fair value in the financial statementsThe total amount of the change in fair value estimated using a valuation technique that was recognised in profit or loss during the period is €28 (2XX3: €19). There are no (2XX3: nil) financial instruments measured at fair value using a valuation technique that is not supported by observable market prices or rates.(End of example)

Nature and extent of risks arising from financial instruments

An undertaking shall disclose information that enables users to evaluate the nature and extent of risks arising from financial instruments to which it is exposed at the reporting date.




These risks typically include credit risk, liquidity risk and market risk.

The disclosures shall be either in the financial statements or incorporated by cross-reference from the financial statements to some other statement, such as a management commentary or risk report, that is available to users on the same terms as the financial statements and at the same time. Without the information incorporated by cross-reference, the financial statements are incomplete.

Qualitative disclosures

For each type of risk, an undertaking shall disclose:

1. the exposures to risk and how they arise;2. (its objectives, policies and processes for managing the risk and the methods used to measure the risk; and

3. any changes in (i) or (ii) from the previous period

Credit quality disclosures

IFRS 7 requires an undertaking to provide disclosures about the credit quality of financial assets that are neither past due nor impaired. The purpose of this disclosure is to give greater insight into the credit risk of fully performing assets and help users assess whether such assets are more or less likely to become impaired in future. How does an undertaking provide such disclosures?

The IASB did not prescribe the manner of these disclosures, as these should be appropriate to the reporting undertaking’s circumstances, which will differ between companies.Companies should therefore devise a method appropriate to their circumstances. Where an undertaking manages its credit exposures using an external credit grading system, an undertaking might disclose information about:

- the amounts of credit exposures for each external credit grade;

- the rating agencies used;




- the amount of an undertaking’s rated and unrated credit exposures; and

- the relationship between internal and external ratings.

If an undertaking manages its credit exposures using an internal credit grading system, an undertaking might disclose information about:

- the internal credit ratings process;

- the amounts of credit exposures for each internal credit grade; and

- the relationship between internal and external ratings.

An undertaking could, for example, group assets based on the length of the business relationship with the counterparty and the counterparty default rates in the past.

An example of this could be as follows: the performing trade receivables consist of new customers (£11,000), existing customers with no previous defaults (£20,000) and customers who had defaulted in the past, but those had been fully recovered (£3,000).

The nature of the counterparty would also provide useful information in this regard.

Market risk –Text example from Illustrated Consolidated Financial Statements 2004- Banks PwCThe Group takes on exposure to market risks. Market risks arise from open positions in interest rate, currency and equity products, all of which are exposed to general and specific market movements. The Group applies a ‘value at risk’ methodology to estimate the market risk of positions held and the maximum losses expected, based upon a number of assumptions for various changes in market conditions. The Board sets limits on the value of risk that may be accepted, which is monitored on a daily basis.

The daily market value at risk measure (VAR) is an estimate, with a confidence level set at 97.5%, of the potential loss that might arise if the current positions were to be held unchanged for one business day. The measurement is structured so that daily losses exceeding the VAR figure should occur, on average, not more than once every 60 days. Actual outcomes are monitored regularly to test the validity of the assumptions and parameters/factors used in the VAR calculation.




As VAR constitutes an integral part of the Group’s market risk control regime, VAR limits are established by the Board for all trading and portfolio operations; actual exposure against limits, together with a consolidated Group-wide VAR, is reviewed daily by management. Average daily VAR for the Group was €187 in 2XX2 (2XX1:€173). However, the use of this approach does not prevent losses outside of these limits in the event of more significant market movements.

12 months to 31 December 2XX4 12 months to 31 December 2XX3Average High Low Average High Low

Interest rate risk

165 179 135 154 173 134

Foreign exchange risk

17 18 15 15 18 12

Equities risk

5 5 2 4 6 2

Total VAR 187 202 152 173 197 148

Quantitative disclosures

For each type of risk, an undertaking shall disclose:

(i) summary quantitative data about its exposure to that risk at the reporting date. This disclosure shall be based on the information provided to key management, such as the board of directors or chief executive officer.

(ii) the disclosures detailed below, unless the risk is not material.

(iii) concentrations of risk if not apparent from (i) and (ii).

If the quantitative data disclosed as at the reporting date are unrepresentative of exposure to risk during the period, an undertaking shall provide further information.

When using several methods to manage a risk exposure, the undertaking shall disclose information using the method or methods that provide the most relevant and reliable information. IAS 8 discusses relevance and reliability.

Concentrations of risk arise from financial instruments that have similar characteristics and are affected similarly by changes in economic or other conditions. The identification of concentrations of risk requires judgement reflecting the circumstances of the undertaking.

Disclosure of concentrations of risk shall include:http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 47



(i) how management determines concentrations;

(ii) the shared characteristic that identifies each concentration (eg counterparty, geographical area, currency or market); and

(v) the amount of the risk exposure associated with all financial instruments sharing that characteristic.

Value at risk (VaR) is a measure (a number) saying how the market value of an asset (or of a portfolio of assets) is likely to decrease over a certain time period (usually over 1 day or 10 days) under usual conditions. It is typically used by security houses or investment banks to measure the market risk of their asset portfolios (market value at risk),

Example

Consider a trading portfolio. Its market value in US dollars today is known, but its market value tomorrow is not known.

The investment bank holding that portfolio might report that its portfolio has a 1-day VaR of $5 million at the 95% confidence level. This implies that (provided usual conditions will prevail over the 1 day) the bank can expect that, with a probability of 95%, the value of its portfolio will decrease by 5 million or less during 1 day, or in other words: it can expect that with a probability of 5% (i. e. 100%-95%) the value of its portfolio will decrease by more than 5 million during 1 day. Stated yet differently, the bank can expect that the value of its portfolio will decrease by 5 million or less on 95 out of 100 usual trading days, in other words by more than 5 million on 5 out of every 100 usual trading days.

Source: http://en.wikipedia.org/wiki/Value_at_risk

Geographical concentrations of assets, liabilities and off-balance sheet items –Example adapted from Illustrated Consolidated Financial Statements 2004- Banks PwCThe following note incorporates credit risk disclosures, geographical concentrations of assets, liabilities and off balance sheet items disclosures and a public enterprise’s secondary segment disclosures.

Total Total Credit Capital Assets liabilities commitments Revenues expenditure

At 31 December 2XX4http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 48



Russia 23,938 22,092 6,716 1,561 187[Other individual countries in Europe over 10% reporting threshold] 29,543 33,211 10,537 3,335 168Other European countries 20,298 16,789 4,981 1,974 73Canada and US 15,390 10,019 2,789 1,075 41Australasia 6,421 5,212 1,069 566 –South-East Asia 3,372 2,760 561 270 –Other countries 2,075 520 – 88 –

Share of associates 112 –Unallocated assets / liabilities 390 5,391

Total 101,539 95,994 26,653 8,869 469

As at 31 December 2XX3

Russia 19,702 14,606 5,986 1,465 143[Other individual countries in Europe over 10% threshold] 25,868 23,433 5,218 2,951 157Other European countries 16,437 15,735 3,873 1,662 40Canada and US 11,390 9,742 2,663 1,109 17Australasia 6,769 6,241 1,367 458 15South-East Asia 4,892 3,772 1,210 367 8Other countries 678 490 – 9 2

Share of associates 108 –Unallocated assets / liabilities 315 7,658

86,159 81,694 20,317 8,021 382




Although the Group’s three business segments are managed on a worldwide basis, they operate in eight main geographical areas. The Group’s exposure to credit risk is concentrated in these areas.

Russia is the home country of the parent bank, which is also the main operating company. The areas of operation include all the primary business segments.In the UK (which is over the 10% reporting threshold in IFRS 8), the areas of operation include all the primary business segments.In other European countries (it is assumed that the countries in this category are individually less than the 10% threshold for a separately reportable segment), the Group operates retail and corporate banking services.

In Canada, the US and Latin America, the predominant activity is corporate banking services.

In Australasia and South-East Asia, the main activities are corporate banking and corporate finance services.

In South-East Asia, the principal countries in which the Group operates are Japan, China and Thailand. As one of the largest Russian banks, the Group accounts for a significant share of credit exposure to many sectors of the economy. However, credit risk is spread over a diversity of personal and commercial customers.

As an active participant in the international banking markets, the Group has a significant concentration of credit risk with other financial institutions. In total, credit risk exposure to financial institutions is estimated to have amounted to €13,637 at 31 December 2004 (2XX3: €12,457), of which €5,061 (2XX3: €3,367) consisted of derivative financial instruments.

The Group restricts its exposure to credit losses on sale and repurchase agreements by entering into master netting arrangements and by holding the underlying securities as collateral. As at 31 December 2XX4, master-netting arrangements reduced the credit risk by approximately €2,734 (2XX3: €2,963).

With the exception of Russia and [other individual countries in Europe over 10% reporting threshold] no other individual country contributed more than 10% of consolidated income or assets.

Interest and fee income, total assets, total liabilities and contingent liabilities have generally been based on the country in which the branch or subsidiary is located, with adjustments made for branches in offshore centres to reflect customers and counterparties that are based elsewhere. The analysis would not be materially different if based on the country in which the counterparty is located.




Capital expenditure is shown by the geographical area in which the buildings and equipment are located.

Geographic sector risk concentrations within the customer loan portfolio were as follows:

2XX4 2XX4 2XX3 2XX3% %

Russia 10,064 17 11,707 22UK 23,113 39 19,153 36Other European countries

13,617 23 11,174 21

Canada and US 4,736 8 4,785 9Australasia 4,144 7 2,128 4South-East Asian countries

1,753 3 3,726 7

Other countries 1,776 3 535 1

59,203 100 53,208 100(End of example)

Credit risk

An undertaking shall disclose by class of financial instrument:

(i) the amount that best represents its maximum exposure to credit risk at the reporting date, without deducting any collateral held or other credit enhancements (such as netting agreements that do not qualify for offset – see IAS 32);

(ii) in respect of the amount disclosed in (i), a description of collateral held as security and other credit enhancements;

(iii) information about the credit quality of financial assets that are neither past due nor impaired; and

(iv) the carrying amount of financial assets that would otherwise be past due or impaired whose terms have been renegotiated.

Maximum credit risk exposure

For a financial asset, this is normally the gross carrying amount, net of:




(i) any amounts offset ( IAS 32); and

(ii) any impairment losses (IAS 39).

Activities that give rise to credit risk and the associated maximum exposure to credit risk include:

(i) granting loans and receivables to clients and placing deposits with other undertakings. The maximum exposure to credit risk is the carrying amount of the related financial assets.

(ii) entering into derivative contracts, such as foreign exchange contracts, interest rate swaps and credit derivatives. When the resulting asset is measured at fair value, the maximum exposure to credit risk at the reporting date will be the carrying amount.

(iii) issuing financial guarantees. The maximum exposure to credit risk is the maximum amount to pay if the guarantee is called on, which may be materially greater than the amount recorded as a liability.

(iv) making a loan commitment that is irrevocable over the life of the facility or is revocable only in response to a material adverse change.If the issuer cannot settle the loan commitment net in cash or another financial instrument, the maximum credit exposure is the full amount of the commitment. This is because it is uncertain whether the amount of any undrawn portion may be drawn upon in the future. This may be greater than the amount recorded as a liability.

Financial assets that are either past due or impaired

An undertaking shall disclose by class of financial asset:

(i) an analysis of the age of financial assets that are past due as at the reporting date but not impaired;

(ii) an analysis of financial assets that are individually determined to be impaired as at the reporting date, including the factors the undertaking considered in determining that they are impaired; and

(iii) for the amounts disclosed in (i) and (ii), a description of collateral held by the undertaking as security and other credit enhancements and an estimate of their fair value.

Collateral and other credit enhancements obtained

When an undertaking acquires financial or non-financial assets during the period by taking possession of collateral it holds as security, or calling on other credit enhancements (such as guarantees), and such assets meet the recognition criteria in other Standards, an undertaking shall disclose:

(i) the nature and carrying amount of these assets; and

(ii) when the assets are not readily convertible into cash, its policies for disposing or for using them in its operations.

(FINREP table 7 provides an Example of a Note regarding Information on Impairment and Past due assets)

Liquidity risk





(i) a maturity analysis for financial liabilities (owed by the undertaking) that shows the remaining contractual maturities; and

(ii) a maturity analysis for derivative financial liabilities. The maturity analysis shall include the remaining contractual maturities for those derivative financial liabilities for which contractual maturities are essential for an understanding of the timing of the cash flows

(iii) a description of how it manages the liquidity risk inherent in (i) and (ii).

For example, the following time bands may be suitable:

(i) within one month;

(ii) later than one month and not later than three months;

(iii) later than three months and not later than one year; and

(iv) later than one year and not later than five years.

When a counterparty has a choice of when an amount is paid, the liability is included at the earliest date on which the undertaking can be required to pay. For example, financial liabilities that can be required to be repaid on demand (eg demand deposits) are included in the earliest time band.

When committed to make amounts available in instalments, each instalment is allocated to the earliest period in which the

undertaking can be required to pay. For example, an undrawn loan commitment is included in the time band containing the earliest date it can be drawn down.

The amounts recorded in the maturity analysis are the contractual undiscounted cash flows, for example:

(i) gross finance lease obligations (before deducting finance charges);

(ii) prices specified in forward agreements to purchase financial assets for cash;

(iii) net amounts for pay-floating/receive-fixed interest rate swaps for which net cash flows are exchanged;

(iv) contractual amounts to be exchanged in a derivative financial instrument (such as a currency swap) for which gross cash flows are exchanged; and

(v) gross loan commitments.

These contrasts with the amounts included in the balance sheet as the balance sheet amount is based on discounted cash flows. (IFRS 7 does not require reconciliations between the discounted and undiscounted cash flows.)

When the amount payable is not fixed, the amount disclosed is calculated by reference to the conditions existing at the reporting date. For example, when the amount payable varies with changes in an index, the amount disclosed may be based on the level of the index at the reporting date.




Loan commitments and IFRS 7

IFRS 7 applies to recognised and unrecognised financial instruments. Recognised financial instruments include financial assets and financial liabilities that are within the scope of IFRS 9.

Unrecognised financial instruments include some financial instruments that, although outside the scope of IFRS 9, are within the scope of IFRS 7 (such as some loan commitments).

Loan commitments and IFRS 7 – credit risk

Activities that give rise to credit risk and the associated maximum exposure to credit risk include, but are not limited to:

making a loan commitment that is irrevocable over the life of the facility or is revocable only in response to a material adverse change.

If the issuer cannot settle the loan commitment net in cash or another financial instrument, the maximum credit exposure is the full amount of the commitment.

This is because it is uncertain whether the amount of any undrawn portion may be drawn upon in the future. This may be significantly greater than the amount recognised as a liability.

When an undertaking is committed to make amounts available in instalments, each instalment is allocated to the earliest period in which the undertaking can be required to pay.

For example, an undrawn loan commitment is included in the time

band containing the earliest date it can be drawn down.

Loan commitments and IFRS 7 – interest rate risk

Interest rate risk arises on interest-bearing financial instruments recognised in the balance sheet (for example loans and receivables and debt instruments issued) and on some financial instruments not recognised in the balance sheet (eg some loan commitments).

IFRS 7 requires the undertaking to describe how it manages the liquidity risk inherent in the maturity analysis of financial liabilities. The factors that the undertaking might consider in providing this disclosure include, but are not limited to, whether the undertaking:

(i) expects some of its liabilities to be paid later than the earliest date on which the undertaking can be required to pay (as may be the case for customer deposits placed with a bank);

(ii) expects some of its undrawn loan commitments not to be drawn.

Guarantees and IFRS 7 – collateral and other credit enhancements obtained

When an undertaking obtains financial or non-financial assets during the period by taking possession of collateral it holds as security or calling on other credit enhancements ((examples of the latter being guarantees, credit derivatives, and netting agreements that do not qualify for offset in accordance with IAS 32)), and such assets meet the recognition criteria in other Standards, an undertaking shall disclose:




(i) the nature and carrying amount of the assets obtained; and

(ii) when the assets are not readily convertible into cash, its policies for disposing of such assets or for using them in its operations.

Guarantees and IFRS 7 – credit risk

Activities that give rise to credit risk and the associated maximum exposure to credit risk include, but are not limited to:

granting financial guarantees. In this case, the maximum exposure to credit risk is the maximum amount the undertaking could have to pay if the guarantee is called on, which may be significantly greater than the amount recognised as a liability.

Guarantees and IFRS 7 – other price risk

There are three types of market risk: interest rate risk, currency risk and other price risk.

Other price risk arises on financial instruments because of changes in, for example, commodity prices or equity prices. An undertaking

might disclose the effect of a decrease in a specified stock market index, commodity price, or other risk variable.

For example, if an undertaking gives residual value guarantees that are financial instruments, the undertaking discloses an increase or decrease in the value of the assets to which the guarantee applies.

For example: a lessor (which may be a bank leasing subsidiary) of motor cars that writes residual value guarantees is exposed to residual value risk.

Liquidity Risk - Example from Illustrated Consolidated Financial Statements 2004- Banks PwC

The table on the following page analyses the Group’s assets and liabilities into relevant maturity groupings based on the remaining period at balance sheet date to the contractual maturity date.

As at 31 December 2004

Up to 1

month

1-3months

3-12months

1-5 years

Over 5

yearsTotal

AssetsCash and central banks balances

6,080 – – – – 6,080

Treasury and other eligible bills

712 773 – – – 1,485

Due from other banks 2,157 3,127 2,507 785 – 8,576Financial assets at fair value through

1,640 1,309 1,898 1,915 1,959 8,721

profit or loss (including trading)Derivative financial instruments

1,301 1,453 1,258 991 322 5,325

Loans to customers 4,676 11,583 24,008 14,432 4,504 59,203Investment securities– available-for-sale – – – 692 3,314 4,006– held-to-maturity – – 1,499 988 1,512 3,999Other assets 328 342 15 12 3,447 4,138




Total assets 16,894 18,587 31,185 19,815 15,058 101,539

LiabilitiesDue to other banks 4,145 4,564 3,813 1,681 836 15,039Other deposits 3,706 4,639 3,219 3,390 1,295 16,249Derivative financial instruments and trading liabilities 1,140 1,072 1,062 580 185 4,039Due to customers 26,056 8,387 12,973 2,445 1,914 51,775Debt securities in issue

55 69 1,076 566 – 1,766

Other borrowed funds

– – – 937 1,871 2,808

Other liabilities 1,316 367 926 597 1,112 4,318

Total liabilities 36,418 19,098 23,069 10,196 7,213 95,994

Net liquidity gap (19,524) (511) 8,116 9,619 7,845 5,545As at 31 December 2XX3

Total assets 17,055 11,703 13,342 24,129 19,930 86,159Total liabilities 38,428 25,159 6,266 6,404 5,437 81,694Net liquidity gap (21,373) (13,456) 7,076 17,725 14,493 4,465

The table shows a short-term funds deficit (up to 3 months), as customers can quickly remove much of their funds.If experience shows this is likely to happen, then the bank will need to provide substantial short-term funds. If not, the bank needs to calculate a likely level of funds required based on historical experience.

Market risk

Sensitivity analysis

A sensitivity analysis is needed for each type of market risk to which the undertaking is exposed.

If an undertaking prepares a sensitivity analysis, such as value-at-risk, that reflects interdependencies between risk variables (eg interest rates and exchange rates) and uses it to manage financial risks, it may use that sensitivity analysis.

The undertaking shall also disclose:

(i) the method used in preparing the sensitivity analysis, and the main parameters and assumptions underlying the data provided; and

(ii) the objective of the method used and of limitations that may result in the information not fully reflecting the fair value of the assets and liabilities involved.EXAMPLE - Sensitivity analysis

FRS 7 requires a sensitivity analysis for each type of market risk. Marketrisk is defined as the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices.; it includes currency risk, interest rate risk and other price risk.

The sensitivity analysis must show the impact of a reasonably possible change in the relevant risk variable on profit or loss and equity.

An undertaking hedges its exposure to variable interest rate risk on an issued bond. The hedge is designated as a cash flow hedge. The bond and the hedging instrument (interest rate swap) have a




five-year remaining life.

If the variable leg of the swap exactly matches the variable interest of the bond (causing no ineffectiveness), how should the undertaking reflect the effect of the hedge on profit or loss and equity in the sensitivity analysis?

The high effectiveness of the hedge does not necessarily mean that there would be no impact on equity or profit or loss due to changes in interest rate risk.

The accounting for a cash flow hedge means that the fair value movement related to the effective part of the hedging instrument is included in equity.

Amounts deferred in equity are recycled in profit or loss when the hedged transaction occurs. Hence, reasonably possible movements in the interest rate risk exposure have an impact on both profit or loss and equity.

At the same time, reasonably possible movements in the interest rate risk exposure on the outstanding bond would impact profit or loss, as the bond was a recognised financial liability at the balance sheet date.

If the effects of recycling and ineffectiveness are not material, the undertaking could consider the following disclosure as an approximation for the sensitivity analysis:

The movements related to the bond and the variable leg of the swap are not reflected, as they offset each other. The movements related to the remaining fair value exposure on the fixed leg of the swap are shown in the equity part

of the analysis.

Market Interest Rate Risk - Example from Illustrated Consolidated Financial Statements 2004- Banks PwC In the table below, assuming the financial assets and liabilities at 31 December 2004 were to remain until maturity or settlement without any action by the Group to alter the resulting interest rate risk exposure, an immediate and sustained increase of 1% in market interest rates across all maturities would reduce net income for the following year by approximately €90 (2003: €75) and the Group’s equity by approximately €270 (2003: €240).

As at 31 December 2003

Up to 1

month

1-3 mont

hs

3-12mont

hs

1-5year

s

Over 5

years

Non-intere

stbeari

ng

Total


4,315 – – – – – 4,315


532 239 – – – – 771


2,257 2,426 1,507 414 – – 6,604




Financial assets at fair value through profit or loss (including trading) 1,643 1,110 1,898

1,305

2,239 1,181

9,376

Loans to customers

8,676 16,583

23,008

4,567

324 50 53,208

Investment securities

– – – 392 1,616

202 2,210

Other assets

228 242 13 10 5 9,177 9,675

Total assets

17,651

20,600

26,426

6,688

4,184

10,610

86,159

LiabilitiesDue to other banks

8,345 3,764 1,015 489 20 – 13,633

Other deposits

1,736 8,639 950 297 409 – 12,031

Due to customers

18,670

11,232

10,276

2,365

134 21 42,698


59 45 870 258 – – 1,232

Other 67 564 1,244 637 – – 2,51

borrowed funds

2

Other liabilities

14 8 7 34 – 9,525 9,588

Total liabilities

28,891

24,252

14,362

4,080

563 9,546 81,694

Total interest sensitivity gap

(11,240)

(3,652)

12,064

2,608

3,621

If not, it shall disclose:

(i) a sensitivity analysis for each type of market risk to which the undertaking is exposed at the reporting date, showing how profit or loss and equity would have been impacted by changes in the relevant risk variable that were reasonably-possible at that date;

(ii) the methods and assumptions used in preparing the sensitivity analysis; and

(iii) changes from the previous period in the methods and assumptions used, and the reasons for such changes.

An undertaking decides how it aggregates information to display the overall picture without combining information with different characteristics about exposures to risks from materially different economic environments. For example:




(i) an undertaking that trades financial instruments might disclose this information separately for financial instruments held for trading and those not held for trading.

(ii) an undertaking would not aggregate its exposure to market risks from areas of hyperinflation with its exposure to the same market risks from areas of low inflation.

If an undertaking has exposure to only one type of market risk in only one economic environment, it would aggregate information.

The sensitivity analysis must show the impact on profit or loss and equity of reasonably-possible changes in the relevant risk variable (such as current market interest rates, currency rates, equity prices or commodity prices). For this purpose:

(i) undertakings are not required to determine what the profit or loss for the period would have been if relevant risk variables had been different. Instead, undertakings disclose the impact on profit or loss and equity at the balance sheet date assuming that a reasonably-possible change in the relevant risk variable had occurred at the balance sheet date and had been applied to the risk exposures in existence at that date. For example, if an undertaking has a floating rate liability at the end of the year, the undertaking would disclose the impact on profit or loss (interest expense) for the current year if interest rates had varied by reasonably-possible amounts.

(ii) undertakings are not required to disclose the impact on profit or loss and equity for each change within a range of reasonably-possible changes of the relevant risk variable. Disclosure of the impacts of the changes at the limits of the reasonably-possible range would be adequate.

In determining what a reasonably-possible change in the relevant risk variable is, an undertaking should consider:

(i) the economic environments in which it operates. A reasonably-possible change should not include remote or ‘worst case’ scenarios or ‘stress tests’. If the rate of change in the underlying risk variable is stable, the undertaking need not alter the chosen reasonably-possible change in the risk variable.

For example, assume that interest rates are 14 per cent and an undertaking determines that a fluctuation in interest rates of ±50 basis points is reasonably possible. It would disclose the impact on profit or loss and equity if interest rates were to change to 13.5 per cent or 14.5 per cent.

In the next period, interest rates have increased to 14.5 per cent. The undertaking continues to believe that interest rates may fluctuate by ±50 basis points (ie that the rate of change in interest rates is stable). The undertaking would disclose the impact on profit or loss and equity if interest rates were to change to 14 per cent or 15 per cent.

The undertaking would not be required to revise its assessment that interest rates might reasonably fluctuate by ±50 basis points, unless there is evidence that interest rates have become importantly more volatile.

(ii) the time frame over which it is making the assessment. The sensitivity analysis shall show the impacts of changes that are considered to be reasonably-possible over the period until




the undertaking will next present these disclosures, which is usually its next annual reporting period.

An undertaking may use a sensitivity analysis that reflects interdependencies between risk variables, such as a value-at-risk methodology, if it uses this analysis to manage its exposure to financial risks.

This applies even if such a methodology measures only the potential for loss and does not measure the potential for gain. Such an undertaking might disclose the type of value-at-risk model used (such as whether the model relies on Monte Carlo simulations), an explanation about how the model works and the main assumptions (such as the holding period and confidence level).

Undertakings might also disclose the historical observation period and weightings applied to observations within that period, an explanation of how options are dealt with in the calculations, and which volatilities and correlations are used.

An undertaking shall provide sensitivity analyses for the whole of its business, but may provide different types of sensitivity analysis for different classes of financial instruments.

Interest rate risk

Interest rate risk arises on interest-bearing financial instruments recorded in the balance sheet (such as loans and receivables and debt instruments issued) and on some financial instruments

not recognised in the balance sheet (such as some loan commitments).

Cash flow interest rate risk - Example from Illustrated Consolidated Financial Statements 2004- Banks PwCInterest sensitivity of assets, liabilities and off balance sheet items – repricing analysis

Cash flow interest rate risk is the risk that the future cash flows of a financial instrument will fluctuate because of changes in market interest rates. Fair value interest rate risk is the risk that the value of a financial instrument will fluctuate because of changes in market interest rates. The Group takes on exposure to the effects of fluctuations in the prevailing levels of market interest rates on both its fair value and cash flow risks. Interest margins may increase as a result of such changes but may reduce or create losses in the event that unexpected movements arise. The Board sets limits on the level of mismatch of interest rate repricing that may be undertaken, which is monitored daily.

The table below summarises the Group’s exposure to interest rate risks. Included in the table are the Group’s assets and liabilities at carrying amounts, categorised by the earlier of contractual repricing or maturity dates. The carrying amounts of derivative financial instruments, which are principally used to reduce the Group’s exposure to interest rate movements, are included in ‘other assets’ and ‘other liabilities’ under the heading ‘Non-interest bearing’.

Expected repricing and maturity dates do not differ significantly from the contract dates, except for the maturity of €27,456 (2XX3: €18,670) of ‘Due to’ customers up to one month, of




which 74% (2XX3: 73%) represent balances on current accounts considered by the Group as a relatively stable core source of funding of its operations.

Up to 1-3 3-12 1-5 Over Non- Total1

monthmonths months years 5

years interest

As at 31 December 2XX4

bearing


6,080 – – – – – 6,080


712 773 – – – – 1,485


3,157 3,647 1,507 265 – – 8,576

Trading securities

1,643 1,619 1,798 1,705 739 1,217 8,721

Loans to customers

12,676 19,583 22,008 4,432 492 12 59,203

Investment securities:– available-for-sale

– – – 892 1,616 1,498 4,006

– held-to-maturity

– 1,000 899 888 1,212 – 3,999

Other assets

328 342 15 12 2 8,770 9,469

Total 24,596 26,964 26,227 8,194 4,061 11,497 101,539

assets

LiabilitiesDue to other banks

9,345 4,764 413 381 136 – 15,039

Other deposits

3,736 10,639 1,219 390 265 – 16,249

Due to customers

27,456 11,987 9,673 1,345 1,284 30 51,775


55 69 1,076 566 – – 1,766

Other borrowed funds

35 439 868 295 1,171 – 2,808

Other liabilities

12 12 267 13 – 8,053 8,357

Total liabilities

40,639 27,910 13,516 2,990 2,856 8,083 95,994

Total interest sensitivity gap

(16,043) (946) 12,711 5,204 1,205

The table below identifies the different rates of interest by currency between assets and liabilities. As the amounts are not included in the table,conclusions as to the impact of interest rate changes need to be noted.Fair value interest rate risk - Example from Illustrated Consolidated Financial Statements 2004- Banks PwC




It summarises the effective interest rate by major currencies for monetary financial instruments not carried at fair value through profit or loss:

As at 31 December 2004 € US$ Swiss Franc

£

% % % %AssetsCash and balances with central banks

4.76 5.34 6.71 4.16

Treasury bills and other eligible bills 4.52 5.65 6.92 4.23Due from other banks 5.01 5.21 6.45 4.22Loans and advances to customers 8.04 7.31 7.28 6.02Investment securities:- available-for-sale debt securities 6.81 6.49 7.85 5.30- held-to-maturity 6.83 6.52 7.90 5.21

€ US$ Swiss Franc

£

Liabilities % % % %Due to other banks 4.93 5.20 6.44 4.20Other deposits 5.22 5.18 6.32 4.18Due to customers 5.90 4.39 5.49 3.99Debt securities in issue 5.32 6.32 6.87 4.43Other borrowed funds 5.35 6.41 6.91 4.45

Assuming the financial assets and liabilities at 31 December 2XX4 were to remain until maturity or settlement without any action by the Group to alter the resulting interest rate risk exposure, an immediate and sustained increase of 1% in market interest rates across all maturities would reduce net income for the following year by approximately €90 (2XX3: €75) and the Group’s equity by approximately €270 (2XX3: €240).(End of example)

Currency risk

Currency risk (or foreign exchange risk) arises on financial instruments that are denominated in a foreign currency (in a currency other than the functional currency (see IAS 21) in which they are measured). For IFRS 7, currency risk does not arise from financial instruments that are non-monetary items or from financial instruments denominated in the functional currency.

A sensitivity analysis is disclosed for each currency to which an undertaking has material exposure.

The table below reflects a bank’s current position in matching currencies and includes credit commitments such as undrawn loans and guarantees.This table does not reflect the settlement dates of the assets and liabilities. These would normally be managed by currency under liquidity risk.

Example -Risk disclosures under IFRS 7http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 62



Undertaking A invests in a foreign currency bond maturing in one year. At the same time it enters into a foreign exchange forward contract with a correspondingmaturity to offset the foreign currency risk.

IFRS 7 requires specific risk disclosures for material risks. Is the materiality of the foreign currency risk on the bond assessed with or without the foreign exchange forward contract?

The materiality of the foreign currency risk on the bond is assessed without the foreign exchange forward contract.

The bond and the foreign exchange forward are dissimilar items (IAS 1, Presentation of Financial Statements). The materiality assessment of the foreign currency risk is therefore performed without considering the foreign exchange forward contract.

However, if it is established that the foreign currency risk is material, the disclosure required in the sensitivity analysis under IFRS 7 is based on the net foreign exchange exposure.

That is, after offsetting the foreign currency bond against the foreign exchange forward contract.

The same approach would apply for the assessment of credit risk, liquidity risk and other market risk.

Currency risk - Example from Illustrated Consolidated Financial Statements 2004- Banks PwC

The Group takes on exposure to effects of fluctuations in the prevailing foreign currency exchange rates on its financial position and cash flows. The Board sets limits on the level of

exposure by currency and in total for both overnight and intra-day positions, which are monitored daily. The table below summarises the Group’s exposure to foreign currency exchange rate risk at 31 December. Included in the table are the Group’s assets and liabilities at carrying amounts, categorised by currency.

Concentrations of assets, liabilities and off balance sheet items

€ US$ Swiss

franc

£ Other Total

As at 31 December 2004AssetsCash and balances with central banks

1,824 912 1,216 1,236 892 6,080

Treasury bills and other eligible bills

100 235 150 1,000 – 1,485

Due from other banks 2,572 1,876 1,715 1,849 564 8,576Financial assets at fair value through profit or loss (including trading)

1,435 2,324 1,365 3,397 200 8,721

Derivative financial instruments

1,643 1,459 398 1,627 198 5,325

Loans and advances to customers

20,264

15,987

6,984 7,873 8,095 59,203

Investment securities: – available-for-sale 1,555 501 432 1,379 139 4,006 – held-to-maturity 998 880 – 2,001 120 3,999Investments in associates

45 21 35 – 11 112

Intangible assets 116 96 61 – – 273Property and equipment

903 275 261 – 80 1,519




Other assets, including tax assets

1,156 264 589 275 99 2,383

Total assets 32,611

24,830

13,206

20,637

10,398

101,539

LiabilitiesDue to other banks 5,785 3,532 2,784 1,169 1,769 15,039Other deposits 6,076 2,478 3,218 3,804 673 16,249Derivative financial instruments And trading liabilities 1,156 589 432 1,576 286 4,039Due to customers 16,15

512,35

43,278 14,83

95,149 51,775


1,194 189 183 200 – 1,766

Other borrowed funds 2,212 93 177 251 75 2,808Other liabilities, including tax liabilities 749 561 634 1,458 679 4,081Retirement benefit obligations

64 32 45 18 78 237

Total liabilities 33,391

19,828

10,751

23,315

8,709 95,994

Net on-balance sheet position

(844) 4,949 2,421 (2,678)

1,689 5,537

Credit commitments 7,432 4,562 3,278 1,324 10,057

26,653

At 31 December 2XX3

€ US$ Swiss

franc

£ Other Total

Total assets 29,772

19,675

11,956

12,905

11,851

86,159

Total liabilities 36,147

16,945

9,657 10,270

8,675 81,694

Net on-balance (6,375 2,730 2,299 2,635 3,176 4,465

sheet position )

Credit commitments 6,234 3,654 2,976 1,234 6,219 20,317




Other market risk disclosuresWhen the sensitivity analyses are unrepresentative of a risk inherent in a financial instrument (for example if the year-end exposure does not reflect the exposure during the year), the undertaking shall disclose that fact and the reason it believes the sensitivity analyses are unrepresentative.

An undertaking might disclose the impact of a decrease in a specified stock market index, commodity price, or other risk variable. If an undertaking gives residual-value guarantees (such as when it leases assets) that are financial instruments, it discloses an increase or decrease in the value of the assets to which the guarantee applies.

Examples of financial instruments that give rise to equity price risk are a holding of equities in another undertaking, and an investment in a trust, which in turn holds investments in equity instruments.

Other examples include forward contracts and options to buy or sell specified quantities of an equity instrument, and swaps that are indexed to equity prices.

The fair values of such financial instruments are affected by changes in the market price of the underlying equity instruments.

The sensitivity of profit or loss (that arises, for example, from instruments classified as at fair value through profit or loss and impairments of available-for-sale financial assets) is disclosed separately from the sensitivity of equity (that arises, for example, from instruments classified as available for sale). (Please see section of Gains and Losses for treatment by financial instrument.)


Fiduciary activities- Example from Illustrated Consolidated Financial Statements 2004- Banks PwC

The Group provides custody, trustee, corporate administration, investment management and advisory services to third parties, which involve the Group making allocation and purchase and sale decisions in relation to a wide range of financial instruments. Those assets that are held in a fiduciary capacity are not included in these financial statements.

Some of these arrangements involve the Group accepting targets for benchmark levels of returns for the assets under the Group’s care. These services give rise to the risk that the Group will be accused of maladministration or under-performance.

At the balance sheet date, the Group had investment custody accounts amounting to approximately €87,000 (2XX3: €68,000) and financial assets under administration estimated to amount to approximately €63,000 (2XX3: €45,000).



Financial instruments that an undertaking classifies as equity instruments are not remeasured. Neither profit or loss nor equity will be affected by the equity price risk of those instruments. Therefore, no sensitivity analysis is required.

Transfers of financial assets

These disclosure requirements relating to transfers of financial assets supplement the other disclosure requirements of IFRS 7. An undertaking shall present the disclosures in a single note in its financial statements.

An undertaking shall provide the required disclosures for all transferred financial assets that are not derecognised and for any continuing involvement in a transferred asset, existing at the reporting date, irrespective of when the related transfer transaction occurred.

For the purposes of applying the disclosure requirements, an undertaking transfers all or a part of a financial asset (the transferred financial asset), only if it either:

(a) transfers the contractual rights to receive the cash flows of that financial asset; or

(b) retains the contractual rights to receive the cash flows of that financial asset, but assumes a contractual obligation to pay the cash flows to one or more recipients in an arrangement.

An undertaking shall disclose information that enables users of its financial statements:

(a) to understand the relationship between transferred financial assets that are not derecognised in their entirety and the associated liabilities; and

(b) to evaluate the nature of, and risks associated with, the undertaking's continuing involvement in derecognised financial assets.

An undertaking has continuing involvement in a transferred financial asset if, as part of the transfer, the undertaking retains any of the contractual rights or obligations inherent in the transferred financial asset, or obtains any new contractual rights, or obligations, relating to the transferred financial asset. The following do not constitute continuing involvement:

(a) normal representations and warranties relating to fraudulent transfer and concepts of reasonableness, good faith and fair dealings that could invalidate a transfer as a result of legal action;

(b) forward, option and other contracts to reacquire the transferred financial asset for which the contract price (or exercise price) is the fair value of the transferred financial asset; or

(c) an arrangement whereby an undertaking retains the contractual rights to receive the cash flows of a financial asset but assumes a contractual obligation to pay the cash flows to one or more undertakings.

Transferred financial assets that are not derecognised in their entirety




An undertaking may have transferred financial assets in such a way that part or all of the transferred financial assets do not qualify for derecognition. The undertaking shall disclose at each reporting date for each class of transferred financial assets that are not derecognised in their entirety:

(a) the nature of the transferred assets

(b) the nature of the risks and rewards of ownership to which theundertaking is exposed.

(c) a description of the nature of the relationship between the transferred assets and the associated liabilities, including restrictions arising from the transfer on the reporting undertaking's use of the transferred assets.

(d) when the counterparty (counterparties) to the associated liabilities has (have) recourse only to the transferred assets, a schedule that sets out the fair value of the transferred assets, the fair value of the associated liabilities and the net position (the difference between the fair value of the transferred assets and the associated liabilities).

(e) when the undertaking continues to recognise all of the transferred assets,the carrying amounts of the transferred assets and the associated liabilities.

(f) when the undertaking continues to recognise the assets to the extent of its continuing involvement, the total carrying amount of the original assets before the transfer, the carrying amount of the assets that the undertaking continues to recognise, and the carrying amount of the associated liabilities.

Transferred financial assets that are derecognised in their entirety

When an undertaking derecognises transferred financial assets in their entirety, but has continuing involvement in them, the undertaking shall disclose, as a minimum, for each type of continuing involvement at each reporting date:

(a) the carrying amount of the assets and liabilities that are recognised in the undertaking's statement of financial position and represent the undertaking's continuing involvement in the derecognised financial assets, and the line items in which the carrying amount of those assets and liabilities are recognised.

(b) the fair value of the assets and liabilities that represent the undertaking'scontinuing involvement in the derecognised financial assets.

(c) the amount that best represents the undertaking's maximum exposure to loss from its continuing involvement in the derecognised financial assets, and information showing how the maximum exposure to loss is determined.

(d) the undiscounted cash outflows that would or may be required to repurchase derecognised financial assets (eg the strike price in an option agreement) or other amounts payable to the transferee in respect of the transferred assets. If the cash outflow is variable then the amount disclosed should be based on the conditions that exist at each reporting date.

(e) a maturity analysis of the undiscounted cash outflows that would or may be required to repurchase the derecognised financial assets or other amounts payable to the




transferee in respect of the transferred assets, showing the remaining contractual maturities of the undertaking's continuing involvement.

(f) qualitative information that explains and supports the quantitative disclosures.

An undertaking may aggregate the information in respect of a particular asset if the undertaking has more than one type of continuing involvement in that derecognised financial asset, and report it under one type of continuing involvement.

In addition, an undertaking shall disclose for each type of continuing involvement:

(a) the gain or loss recognised at the date of transfer of the assets.

(b) income and expenses recognised, both in the reporting period and cumulatively, from the undertaking's continuing involvement in the derecognised financial assets (eg fair value changes in derivative instruments).

(c) if the total amount of proceeds from transfer activity (that qualifies for derecognition) in a reporting period is not evenly distributed throughout the reporting period (eg if a substantial proportion of the total amount of transfer activity takes place in the closing days of a reporting period):

(i) when the greatest transfer activity took place within that reporting period (eg the last five days before the end of the reporting period),

(ii) the amount (eg related gains or losses) recognised from transfer activity in that part of the reporting period, and

(iii) the total amount of proceeds from transfer activity in that part of the reporting period.

An undertaking shall provide this information for each period for which a statement of comprehensive income is presented.

Supplementary informationAn undertaking shall disclose any additional information that it considers necessary to meet the disclosure objectives.

Brief Notes on FINREP and Prudential Supervision of Banks

Supervision of banks and many other financial institutions is a major activity of central banks (including CBRF), and other supervisors (their idundertakings varying between countries: Federal Reserve Bank=US, Bank of England=UK).

Prudential supervision by these organisations has confidence in the national banking system as a primary concern (and as a second, the international banking system). CBRF produces comprehensive annual reports in both Russian and English on its supervision procedures and practice, at the foot of the first page of its website: www.cbr.ru/www.cbr.ru/eng/daily.aspx



http://www.cbr.ru/


A failure of a major bank may create a domino effect causing other innocent banks nationally and internationally to fail, or be seriously weakened.

Prudential supervision has more emphasis on liquidity than profitability to assess whether (or not) a bank can survive a short-term crisis. Reports from banks to the supervisors range between daily (such as liquidity) and annual (details on auditors).

Given the different objectives and requirements of the supervisors and IFRS, banks and financial institutions (such as insurance companies and investment funds) have sought to provide financial statements that please both supervisors and IFRS at minimal cost.

The European Banking Authority (formerly CEBS) has addressed this issue and produced FINREP. FINREP will be the standard for European banks to use for their financial reporting to encompass both prudential and IFRS requirements.

The English edition of FINREP has been available since December 2005 on the EBA / CEBS website (http://www.eba.europa.eu/Home.aspx ).

We attach it to our workbook with all the accompanying documents and acknowledge that the copyright of all of this material resides with EBA. The English text takes precedent over any translation into other language. The originals and any updates are to be found on the EBA website.

We are privileged to have been allowed by the EBA to translate the FINREP documents into Russian (the translation of which we are responsible for).

We recognise that neither the IASB nor CBRF have endorsed FINREP, but we have translated it as contribution to the further development of financial reporting in Russia.

FINREP also illustrates how financial statements will appear. Such illustrations were not included in IFRS 7. This is an additional major benefit of FINREP to our readers, many of whom have limited experience of IFRS financial statements of banks and financial institutions.

Understanding the financial statements of banks and other financial institutions is likely to become increasingly complicated. This reflects the increased complexity of these institutions in global markets and a plethora of new financial instruments every year.

To our readers who do not produce or audit IFRS statements of financial institutions, we suggest that you download the IFRS financial statements of major banks in your country and contrast the presentation with FINREP to identify quantitive differences and this workbook for the qualitative differences.

These financial statements of major IFRS-compliant banks will also give an idea of the quality and amount of detail required to comply with IFRS 7 (and perhaps FINREP) that is adequate without becoming excessive.

We hope that our IFRS 9 + five IAS 32/39 books will also provide help in this complex area of financial reporting.



http://www.eba.europa.eu/Home.aspx




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