Testing banks' transparency in times of financial turmoil
A new report from PricewaterhouseCoopers reveals the extent to which banks' reporting has been tested by the credit crisis and how banks have responded in terms of disclosure.
Based on the 2007 annual reports of 22 global banks, "Accounting for change: transparency in the midst of turmoil" provides a targeted review of bank disclosure requirements and proposes best practice recommendations for the three areas most affected by market events – fair value, structured finance and risk management. It also benchmarks current findings against the 2006 "Accounting for change" survey from PricewaterhouseCoopers.
The report finds that in challenging times, on the whole there has been improvement since the previous survey. Banks demonstrated an increase in fair value disclosures and also in the range and depth of structured finance disclosures. However, although banks have expanded their disclosures in areas most impacted by the recent credit crisis, this increase has perhaps not achieved the level of transparency that users of financial statements are demanding. Despite compliance with accounting standards, the disclosures gave a less cohesive picture of the banks' position on risk, for example, than the market is looking for.
Nicholas Ganz, Capital Markets Group, PricewaterhouseCoopers commented:
"Increased scrutiny from investors and regulators combined with the implementation of new financial reporting standards around risk management, fair value measurement and disclosure, have coincided with a period of severe volatility in the most advanced financial markets. These challenges have put huge pressure on existing frameworks.
"Faced with a difficult environment, banks have coped well with a number of issues. However, with the market challenges racing ahead of regulation, boilerplate compliance is no longer going to crack the problem. Banks have reached a fork in the road – they need to provide quality disclosures that tell the full story. Otherwise, we could be looking at the voluntary disclosure framework giving way to more prescriptive disclosure from regulators."
Fair value
The implementation of IFRS 7 – Financial Instruments: Disclosures and SFAS 157 – Fair Value Measurements, along with the fallout from the market turmoil, has reinvigorated the fair value debate and, to varying degrees, has had a positive impact on the nature and extent of fair value disclosures. The survey notes an overall increase and improvement in disclosures on the use of fair value which is particularly evident in those areas most impacted by the turmoil and where the banks discussed valuation techniques using significant unobservable inputs.
There was also an increase in the disclosures on credit and liquidity risks and the impact of changes in these variables on valuations. By comparison, the 2006 survey found that the nature and extent of disclosures under fair value varied widely and that there was a lack of transparency around the valuation techniques applied.
Francois Prinsloo, Financial Services Practice, PricewaterhouseCoopers, said:
"Our analysis has identified a number of areas where we think fair value disclosure practices could be improved. Disclosure of valuation methodologies could be more comprehensive and provide more detailed discussion of underlying assumptions used and how these could change under different market conditions. The provision of a more detailed sensitivity analysis or a range of estimates would greatly assist users of the financial statements to understand how banks have addressed subjective areas of valuation."
Structured finance
The current spotlight on structured finance has done little to harmonise disclosures around the type, extent and complexity of structured finance activities. While there has been an improvement due to the addition of new disclosures since the last survey, with certain banks providing detailed, tailored quantitative information, other provided only brief qualitative information on one activity, or in some cases, no information at all.
Francois Prinsloo, Financial Services Practice, PricewaterhouseCoopers, said:
"Structured finance is firmly at the top of international policy-makers' agenda, as evidenced by the volume of initiatives focused on reviewing existing regulations relating to structured products. Our survey shows, however, that financial statement users may still find it difficult to assess fully the exposure and risks related to banks' structured finance activities.
"We would recommend that the introduction of additional guidance, aimed at improving transparency focuses on a framework of disclosure rather than prescribing a detailed set of information requirements."
Risk management
The survey results indicate that there was not the improvement in the transparency of risk management disclosure that was anticipated with the implementation of IFRS 7. Due to the challenges of applying the requirements of the standard for the first time, the banks tended to focus on compliance with the minimum standards, rather than taking the opportunity to present a comprehensive and clear picture of how they manage risk. The result was a disjointed set of disclosures that did not tell a clear story."
Francois Prinsloo, Financial Services Practice, PricewaterhouseCoopers, said:
"It will be interesting to see how banks deal with their reports a year into the credit crisis. Above all, it is not simply a question of more disclosure, but about disclosing the information that investors want and that management has used to reach its assumptions and decisions."
