The European banking activity depends on two sets of rules: Basel 2, that defines the need for regulatory capital, and the IFRS accounting norms (International Financial Reporting Standards). Both are significantly more complex than the former rules. Particularly, they are based on some mathematical models that have been proposed in the financial sector during the last twenty years: Value-at-Risk, its application to credit portfolio modeling and operational risks, the valuation of structured products, etc. Due to this sophistication, Risk Control and Financial departments, auditors, supervisors etc have to rely on some high-level « quant » teams to understand and apply these rules conveniently. Now, the latter rules are so important that no board of a bank will take an important decision without evaluating its consequences in accounting and regulatory terms. In parallel, the financial innovation has been fuelled by balance-sheet management and regulatory arbitrage. Finally, the accounting and regulatory rules are keys to understand the recent financial crisis and its implications. This lecture will provide the basis of this accounting and regulatory culture, with a view towards practical applications and quantitative tools.
The basics of accounting [Nicolas Patrigot, CNCE]
– History of the IFRS rules. The link with US norms USGAAP.
– The main principles of the IFRS rules.
– The regulatory framework : IASB / European Union / AMF / auditors / Commission Bancaire / Conseil National de la Comptabilité
– Overview of the IFRS rules
– A reminder about bank balance sheets and Profit & Loss statements; items of a balance sheet: banking/trading book, loans and receivables, fair value option, goodwills, debts, capital…
– Debt consolidation : the case of ad-hoc entities
– The financial crisis through the view of accounting rules : the example of IAS 39 in October 2008 (transfers between trading books and banking books)
Fair Value principles
– Fair value definition
– Application: observable market parameters; impact of market liquidity
– Mark-to-Model valuations
– Day one profit in a trading book
– Fair value of liabilities by taken into account own credit spread variations
– The case of incorporated derivatives
– Asset and Liabilities management, macro-hedging, carve-out, IFRS 39, efficiency tests of hedging strategies, CDS and accounting rules for hedging instruments.
Impairment and efficiency tests
– Principles of depreciation
– Depreciation / impairment of portfolios
– Depreciation of goodwills
Capital, debt, hybrid debt
– Typology of liabilities of a bank
– Link between IFRS and regulatory rules, regulatory filters
– Capital management, solvability ratio, debt restructuring
Bâle II and other directives [Bertrand Chavasse, BNP-Paribas]
– Basel committee / European Commission/ Commission Bancaire
– The different approaches proposed in Basel 2
IRB (Foundation and Advanced)
-Capital calculation : principles
K = EAD * RW * 8% : details of the components
Explanation of the Basel 2 formula
Some concrete examples (vanilla financing, structured financing, OTC derivative) : regulatory capital calculation, impact on pricing and return
CVA on OTC instruments : principles, calculations
Credit risk mitigation
-The current financial crisis and the answers of regulators
New rules for trading books (default risk, securitization)
Penalties on securitization of securitizations
DUMONTIER P. et DUPRE D. (2005) : Pilotage bancaire : les normes IAS et la réglementation Bâle 2, Revue Banque édition.
RAFFOURNIER B. (2005) : Les normes comptables internationales (IFRS/IAS), Economica.
Arrêté du 20 février 2007 relatif aux exigences de fonds propres applicables aux établissements de crédit et aux entreprises d’investissement
DIRECTIVE 2006/48/CE DU PARLEMENT EUROPÉEN ET DU CONSEIL du 14 juin 2006 concernant l’accès à l’activité des établissements de crédit et son exercice (refonte)
International Convergence of Capital Measurement and Capital Standards (Basel Committee)