Basel Committee issues guidance on the use of the fair value option for financial instruments by banks

The Basel Committee on Banking Supervision released today Supervisory guidance on the use of the fair value option for financial instruments by banks, a paper providing banking supervisors with guidance on this topic.

The supervisory guidance is structured around seven principles that fall into two broad categories: (a) Supervisory expectations relevant to the use of the fair value option, and (b) Supervisory evaluation of risk management, controls and capital adequacy. The paper addresses such matters as bank risk management and capital assessment issues.

Mr Jaime Caruana, Chairman of the Basel Committee and Governor of the Bank of Spain, commented that "Banking organisations are mainly employing the fair value option to better reflect sound economic hedging strategies in today's mixed-attribute accounting framework. Banking supervisors have recognised the need to communicate fundamental supervisory expectations in this important and sensitive area." He added, "I believe this paper will provide supervisors with essential tools for this purpose."

Professor Arnold Schilder, member of the Basel Committee, Chairman of its Accounting Task Force and Executive Director of the Netherlands Bank, remarked "Bank supervisors expect bankers to implement sound risk management and controls surrounding decisions to designate and subsequently measure financial instruments at fair values. This paper should enhance bankers' understanding of supervisory expectations regarding this option."

This supervisory guidance is not intended to set forth additional accounting requirements beyond those established by robust accounting standards. While this guidance refers specifically to the fair value option in IAS 39, as amended on 16 June 2005, similar fair value option approaches exist or are being considered in several other accounting regimes. The principles set forth should be generally applicable in such other regimes, although national supervisors will need to assess the criteria and requirements of the fair value option in their jurisdictions. The paper focuses on supervisors' expectations for key policy positions and for sound risk management, valuation and control practices that together will maintain the integrity of regulatory capital measures.