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Build a world-class employee experience today. Watch a 3-minute demo Speak to our team. Close banner. Banks will need to understand the value of their balance sheets better and faster to have a seat at the table when it comes to discussing resolution plans with the authorities.
New rules on capital are being phased in by the European Banking Authority from January If banks are able to demonstrate to resolution authorities that they can value their assets and liabilities robustly in the event of a resolution, they may even be able to argue for a lower capital requirement. This legislation provides authorities with greater powers when dealing with failing banks.
The new thinking is that financial institutions should be able to fail without significant consequences — in the same way that non-financial firms can like Woolworths and Blockbuster. The significant consequences to be avoided are excessive disruption to the financial system, interruption to critical economic functions and exposing taxpayer money to losses.
The European Commission has decided to ensure that the cost of such failure is borne by shareholders and creditors rather than the taxpayer. In thinking through the practical application of these tools, it quickly becomes clear that valuation is key to resolution. In the case of bail-in it quantifies the recapitalisation need. In the case of sale or transfer, the assets being sold or transferred must change hands at a fair value.
In order to assess this we need — you guessed it — more valuations. The EBA has issued draft legislation covering the various valuations banks need to be able to perform:. The requirement to be able to perform valuations quickly, accurately, at short notice and possibly mid-month is likely to present a significant challenge for most institutions. Merely assembling the information required for such exercises can be tricky and time-consuming when dealing with multiple systems and data repositories, potentially in numerous jurisdictions.
Performing such valuations might sound simple enough. But when you lift the lid and get into the finer details such as the intricacies of loan portfolios, exotic derivatives, complex off balance sheet structures, pension scheme deficits, intra-group funding arrangements and contingent liabilities , things can get complicated very quickly. Not quite. Financial institutions perform various valuations for existing risk management, accounting and regulatory requirements but none of them really fit the bill for resolution.
They already estimate fair value for IFRS 7 disclosures, but the level of detail is usually much lighter than what is required for resolution valuations. There are similarities to IFRS 9, which will see banks estimating lifetime losses on loan portfolios. But IFRS9 does not incorporate the interest rate adjustment element of fair value, so only gets you part of the way. It is worth considering whether existing projects, such as IFRS 9 or stress testing, could be adapted or leveraged for this purpose.
Perhaps it may be. While the cost of establishing valuation capabilities may be significant, there are benefits to be had.
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