Core Deposits

The ED proposed that a core deposit cannot qualify for fair value hedge accounting for any time period beyond the shortest period in which the counterparty can demand payment.

The staff noted that many respondents requested that core deposits be included in a portfolio hedge by scheduling them to the date when, based on conservative assumptions, the entity expects the total amount of core deposits in the portfolio to fall because of net withdrawals. This expected repayment date is typically a period several years into the future.

The Board considered an alternative approach of including core deposits in a portfolio hedge based on the expected repayment date of the existing balance (ignoring any replacements of existing deposits by future new deposits). The Board also considered under this approach whether the expected repayment date of the existing balance should be determined by:

• attributing outflows of cash to the oldest deposits making up the existing balance (a 'FIFO approach'). Applied to a chequing account, this approach would likely give an expected life of a few months; or
• attributing outflows of cash to the most recent deposits making up the existing balance (a 'LIFO approach'). Applied to a chequing account, this approach would likely give an expected life for a 'base level' or 'minimum balance' on the account of many years.

The Board also considered whether the above would imply it should also change in its view as to what is the fair value of such a core deposit or whether the fair value of a core deposit cannot be less than the present value of the amount that the depositor can demand (which is the present requirement of IAS 39), but that there is also an intangible asset for the customer relationship (a 'core deposit intangible') whose value changes as interest rates move and hence that might qualify as the hedged item in a fair value hedge of interest rate risk.

The staff recommended that:

• a. The proposal in the ED that a core deposit cannot qualify for fair value hedge accounting for any time period beyond the shortest period in which the counterparty can demand payment be reconsidered.
• b. A core deposit be permitted to be included in a portfolio hedge of interest rate risk based on the expected repayment date of the existing balance. Rollovers or replacements of existing deposits by new deposits would not be included in the expected repayment date.
• c. Consistent with (b), the expected repayment date of the existing balance is determined using a FIFO approach.
• d. Consistent with (b), the requirement in IAS 39.49 for fair valuing core deposits be changed to read as follows:

  "The fair value of a financial liability with a demand feature (eg a demand deposit) is not less than the amount payable on demand, discounted from the first date that the amount could be required to be paid reflects when the amounts payable are expected to be paid. Rollovers or replacements of existing liabilities by new liabilities (eg from new deposits being made into a demand deposit account) are excluded in estimating when the amounts payable are expected to be paid."

• e. IAS 39 requires that any difference between the fair value on initial recognition of a core deposit and the amount deposited is recognised as a separate liability, being prepaid servicing costs, and is amortised on a systematic and rational basis over the expected life of the deposit.

The Board did not support the staff's recommendations and retained the approach to core deposits as exposed. They reiterated that cash flow hedging remained available and requested the staff to continue working on the core deposit measurement issue.

The Board further agreed that hedging of fixed term accounts should also be considered further.

Designation and Hedge Effectiveness

The staff gave a brief recap of the exposure draft's proposals as follows:

• The hedged item may be designated as an amount of assets or liabilities rather than as individual assets or liabilities.
• Although the portfolio may include, for risk-management purposes, assets and liabilities, the hedged item is designated is an amount of assets or liabilities. Designation of a net amount including assets and liabilities is not permitted.
• When the hedged item is based on expected repricing dates, the effect that changes in the hedged interest rate have on those expected repricing dates shall be included when determining the change in the fair value of the hedged item. Accordingly, when interest rate changes cause prepayment estimates to change, hedge ineffectiveness will arise, both when such changes cause the entity to become over-hedged and when they cause it to become under-hedged.

The staff provided details of comments on those issues.

The staff recommended the following:

• a. The proposal that the net position cannot be designated as the hedged item be retained. The Board agreed.
• b. When the hedged item is designated as an amount, guidance on how that amount is to be determined is retained. The method for designating the hedged item and measuring effectiveness should not be left completely open . The Board agreed.
• c. A method of designation that results in ineffectiveness when interest rate changes cause prepayment estimates to change, regardless of whether such changes cause the entity to become over-hedged or under-hedged should be retained. That is, the requirement that the change in the value of a hedged prepayable asset that is attributable to interest rates should include the effect that interest rates have on prepayment rates should be retained. However, this may be achieved in one of two ways:
  • If the prepayment option is required to be separated and measured at fair value, or if the entity is able to separately measure the fair value of a non-separated prepayment option, it should use this method. (It was clarified that this would merely be a more precise measure than what is allowed below.)
  • In other cases, the entity should use the percentage method proposed in the exposure draft.
  The Board agreed. It was noted that this meant that prepayments as a result of interest rate changes needed to be included in the hedge.
• d. It should be clarifed that when prepayment estimates change because of factors other than changes in interest rates, no ineffectiveness arises. The Board deferred a decision on (d) unless the staff provided further details and proposed wording.

3 Board members indicated that they may dissent based on decisions to date.