Fair value measurement and modelling: An assessment of challenges and lessons learned from the market stress

Recognising the critical importance of sound valuations to risk management, financial reporting and regulatory capital adequacy, in early 2007 the Basel Committee on Banking Supervision initiated a project to gain a deeper understanding of approaches used to determine valuations of complex financial instruments. Within the context of existing accounting standards, the Committee's work focused on the use of valuation methodologies for risk management and financial reporting purposes. It also assessed the related control, audit and governance practices surrounding fair value measurement. In response to the market turmoil that emerged during mid-2007, the scope of the work was subsequently expanded to include coverage of how banks responded to the market stress and initial lessons learned.

Drawing on the work of the Committee's Accounting Task Force and Risk Management and Modelling Group, this paper summarises the Committee's initial assessment of valuation practices. To strengthen practices and promote greater transparency regarding valuation processes, the Committee is undertaking further work to develop guidance that supervisors can use to assess the rigour of banks' valuation processes and promote improvements in risk management and control practices. The Committee will also work with accounting and auditing standard setters and auditors to promote standards and practices that enhance the reliability, verifiability and transparency of fair value estimates. These initiatives will build off existing Basel Committee and industry guidance. They are also part of a broader effort by the Committee and national supervisors to strengthen firm-wide risk management practices.