ECB concerns about fair value, convergence

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28 Apr 2010

Gertrude Tumpel-Gugerell, member of the Executive Board of the European Central Bank (ECB), spoke on Elements for intervention on accounting issues at a conference in Paris on Paris on 27 April 2010.

Click to Download Ms Tumpel-Gugerell's Remarks (PDF 56k).
Here are several excerpts in which she presents the views of the ECB on fair value measurement, impairment, and convergence:

Fair value measurements

First, in our view fair value accounting does not provide decision-useful information to investors if the intention of an entity is to hold the assets until maturity or to settle the liabilities at their nominal amount at maturity. In these cases, recognising interim fair value changes simply heightens the volatility of the financial accounts, without providing actual 'information content'. This is typically the case for the loan book of commercial banks.

Moreover, the ECB does not agree that an entity is required to record a gain when the fair value of its own debt falls due to a decrease in its creditworthiness. The rationale being that the entity could buy back the debt and realise the profit. However, in reality and especially in times of distress, an entity does not have readily available the extra cash to buy back their debt....

Second, with regard to its application, fair value accounting poses certain operational challenges, namely when markets become illiquid and reliable market prices are no longer available. What is the use of marking-to-market when there is no market? The relevance and reliability of fair values based on market prices require a functioning market where prices adequately reflect the underlying fundamentals of the financial instrument. When the market is significantly disrupted, the use of market values may be utterly meaningless....

Hence the ECB is of the opinion that fair value measurement should only be required if it is consistent with the institution's business model and the characteristics of the particular underlying asset or liability.

Impairment of financial assets

Pre-crisis provisioning practices delayed the recognition of credit losses inherent in loans. Accounting rules require a specific trigger event, such as a default in payment to take place before allowing an entity to create provisions for credit losses. As a result, major write-offs usually accumulate during severe downturns when the inherent credit losses actually materialise, adding further stress to the financial system.

Hence, a more forward-looking provisioning methodology should be developed. This has also been a recommendation of the G20 Leaders. In this context, the ECB welcomes the recent IASB proposal for an expected cash flow approach. Despite some operational challenges that need to be resolved before its final adoption, this approach allows for a timelier recognition of expected credit losses, thereby contributing to mitigating pro-cyclicality. In this context, it should be noted that the Basel Committee has recently developed an approach which aims at reducing the complexity of the IASB's approach. The ECB urges the IASB to work together with the Basel Committee with a view to developing a workable solution to a more forward-looking provisioning approach.

This is also a good example of where the objectives of high quality accounting and safeguarding financial stability complement each other.

On that note, let me finally underline that the ECB acknowledges the work of the IASB and welcomes the progress that has been achieved in the accounting framework. We look forward to continuing the intense dialogue with the IASB on the remaining phases of the financial instruments project, as well as other accounting areas that may be of importance from a regulatory perspective.


For all these reasons, the ECB welcomes the ongoing efforts of the accounting standard setters to achieve fully compatible, high-quality accounting standards in a direct response to the G20 request. However, we are concerned to hear that the FASB and the IASB are still far from reaching a consensus on key accounting concepts, such as the classification and measurement of financial instruments. The IASB has confirmed a 'mixed measurement model' that measures financial instruments both at amortised cost and fair value. In contrast, the US standard setter, the FASB, is determined to move towards a 'full fair value model', claiming that only fair value provides decision-useful information to investors.

I have already mentioned in my intervention how the financial crisis has blatantly revealed the flaws with this measurement and how in certain circumstances, namely when markets are dislocated, applying full fair value accounting to the financial statements of the banking sector raises financial stability concerns and does not provide decision-useful information to investors.

Just to re-emphasise, the ECB strongly opposes a full fair value approach. In this context, convergence should not come at the expense of high-quality accounting standards.

Finally, with regard to recent assertions made by the IASB and FASB that convergence is on track, I would like to highlight that we are not so optimistic. In this regard, putting in place a reconciliation mechanism that simply discloses figures at amortised cost and fair value for each item on the balance sheet would certainly not achieve the aim of convergence.

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