Supervisory guidance on the use of the fair value option for financial instruments by banks

Objective and summary

This paper is being issued by the Basel Committee on Banking Supervision to provide supervisors with guidance on the prudential supervision of banks' implementation of the fair value option. The guidance is principles-based and is structured around seven principles that fall into the following two broad categories:

Supervisory expectations relevant to the use of the fair value option

1. Supervisors expect a bank's application of the fair value option to meet the criteria set forth in IAS 39 in form and in substance.
2. Supervisors expect banks to have in place appropriate risk management systems (including related risk management policies, procedures and controls) prior to initial application of the fair value option for a particular activity or purpose and on an ongoing basis.
3. Supervisors expect that banks will not apply the fair value option to instruments for which they are unable to reliably estimate fair values.
4. Supervisors may require banks to provide supplemental information to assist them in assessing the impact of banks' utilisation of the fair value option.

Supervisory evaluation of risk management, controls and capital adequacy

1. Supervisors should evaluate a bank's risk management and control practices as they pertain to the use of the fair value option.
2. Supervisors should consider risk management and control practices related to the use of the fair value option when assessing capital adequacy.
3. Regulatory capital should be adjusted for gains and losses from changes in own credit risk as a result of applying the fair value option to financial liabilities.

While this supervisory guidance refers specifically to the fair value option in IAS 39, the Committee believes that the principles set forth in this document should be generally applicable to similar fair value option approaches that exist or are being considered in other accounting regimes. National supervisors will need to make this determination based on the criteria and requirements of the fair value option in their jurisdiction.

The supervisory guidance is not intended to set forth additional accounting requirements beyond those established by the IASB. Instead, this supervisory guidance addresses such matters as bank risk management and capital assessment issues, and thus should not be in conflict with the IASB's accounting and disclosure guidance on the fair value option.