Derivative and Hedge Accounting by Banks

A subject as crucial as accounting for derivatives would have been better done justice to if the professional body and the central bank had put their heads together, rather than go on separate paths of standard evolution and reinvent different wheels, says D Murali in Business Line.

- Dilip.

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On separate paths of standard evolution

Source: Business Line, 13-07-2006

Recently, the Reserve Bank of India issued a `discussion paper' on `Derivative and Hedge Accounting by Banks'. This was based on the proposals made by an internal group formed by the RBI to formulate guidelines for the purpose.

These proposals are `largely based on the principles of IAS 39,' noted the RBI. The reference is to the International Accounting Standard (IAS) titled `Financial Instruments: Recognition and Measurement', which was issued in December 2003.

How far does the RBI's paper address the current practices? Dinesh Arora, Associate Director, PricewaterhouseCoopers, is of the view that when implemented, the proposals will place requirements on banks to document and measure the effectiveness of a hedge on a continuous basis. "This will help in dissemination of due information to all the stakeholders, and also assist the management in prudent decision-making," he says.

On whether there would be difficulties when applying the proposed norms of disclosure, Arora concedes that determination of fair value of derivative contracts is a complex process. "Also, since the derivative market is evolving at a fast pace, you get to see new products every now and then. As a consequence, the accounting exercise becomes even more challenging."

Wouldn't it have been better if the accounting norms had come from the Institute of Chartered Accountants of India (ICAI)? As if to pre-empt such a poser, the RBI has a defensive explanation in the intro to the discussion paper, in Para 1.2. There, the central bank acknowledges that the Accounting Standards Board (ASB) of the ICAI is engaged in the process of considering the subject. "The proposed Accounting Standard (AS) will address accounting of derivatives, among others," states the RBI. "However, the formal introduction of the AS for recognition and measurement of financial instruments in India by the ICAI is likely to take some time."

One more instance of how the premier accounting body has not been keeping pace with the requirements of the finance world, critics may point out. But one learns that the ASB has already finalised the draft of the proposed AS on `Financial Instruments: Recognition and Measurement'.

T. N. Manoharan, President of the ICAI, informs that the draft AS is broadly based on IAS 39. The forthcoming standard aims to lay down "recognition and measurement principles for all financial instruments, including derivative instruments, in a comprehensive manner," he elaborates.

Manoharan says that the draft of the proposed AS will be circulated shortly `among the specified outside bodies and other interest groups, for comments'. After considering the comments received, the ASB will finalise the Exposure Draft of the proposed AS and issue the same for public comments. "The final AS on the subject is expected to be released by the end of this year," outlines Manoharan.

By which time, the central bank's norm should be out. In Act I, Scene I of The Taming of the Shrew, Tranio tells Lucentio, "Master, for my hand, both our inventions meet and jump in one." He gets a fast response: "Tell me thine first." Is the ICAI more like Lucentio? Perhaps, a subject as crucial as accounting for derivatives would have been better done justice to if the professional body and the central bank had put their heads together, rather than go on separate paths of standard evolution and reinvent different wheels.

While still on the derivative theme, it may help to know that the Basel Committee on Banking Supervision of the Bank for International Settlements (www.bis.org) has released a 22-page `supervisory guidance' on `the use of the fair value option for financial instruments by banks.'

http://AccountSpeak.blogspot.com

D. Murali