CEBS reports on bank transparency and illiquid product valuations

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LONDON – In response to the roadmap issued by the EU Economic and Financial Affairs Council (Ecofin) in October 2007 following the credit crisis, the Committee of European Banking Supervisors (CEBS) has issued the findings of its assessment of bank transparency with regard to the activities and instruments affected by the recent market turmoil.

CEBS analysed the disclosures made by 22 large banks (19 originate from the EU) in the context of their 2007 fourth-quarter and preliminary results and 2007 audited annual reports. The assessment covered disclosures on exposures and their affect on results, and information on the banks’ business models, risk management, and accounting and valuation practices.

The main findings of the analysis showed that institutions made: limited disclosures on the business models underlying the activities affected by the subprime crisis and related risk management practices (especially liquidity risk); diverse disclosures on exposures and on the affect of the crisis; generic disclosures on the valuation of exposures affected by the market turmoil and their accounting; and varied presentations of disclosures.

But there were instances of best practice. The CEBS states banks make comprehensive disclosures on business model and risk management; meaningful disclosures on exposures and impacts, with appropriate levels of granularity; useful disclosures on accounting policies; and have improved their presentation of disclosures.

CEBS states these observed good practices contribute to the improvement of disclosures on exposures and activities affected by the market turmoil. They are also consistent with the recommendations made in the report by the Financial Stability Forum, Enhancing market and institutional resilience, and with the Senior Supervisors Group’s paper, Leading practice disclosures for selected exposures.

The Committee recommends the application of the observed good practices by all banks, albeit in a manner commensurate with an institution’s exposures and involvement in the activities affected by the crisis. As disclosure practices develop, along with the high-risk areas that require specific attention, CEBS intends to investigate how good practices should be applied in the longer run and will also continue to closely monitor the disclosures by institutions in their forthcoming (half-year) reports before deciding on any further measures.

CEBS has also issued a report on issues regarding the valuation of complex and illiquid financial instruments. The report puts forward a set of issues that should be addressed by institutions, and accounting and auditing standard setters, to improve the reliability of the values ascribed to these instruments. The major challenged include ensuring institutions enhance their practices and governance surrounding the use of modelling techniques; ensuring that all appropriate risk factors are considered when determining a fair value; and improving risk management practices to ensure adequate risk assessment of transactions and appropriate management of exposures, among others.

On transparency, institutions are advised to enhance their disclosures on fair value and on valuation techniques. The report says accounting standard setters should review the disclosure requirements to enhance the information to be disclosed on fair values and valuation techniques. Likewise auditors should pursue their efforts to enhance the guidance for the audit of fair value estimates.

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