Applying IFRS in Romanian banks. Challenges from the management and audit perspective

Noiembrie 2011

TUDOR GRECU - Audit Director, KPMG - Financial Services KPMG ROMÂNIA S.R.L.

 

Introduction

In international markets there is a need, now more than ever, for stability and increased financial transparency. Promoting a set of global accounting standards is an important step in this direction. Internationally, the convergence process has been marked by the unprecendented cooperation between the International AccountingStandards Board (IASB) and the Financial Accounting Standards Board (FASB). The last joint report issued by them on April 21^st, 2011 emphasized the substantial progress made over the last year in the convergence process between InternationalFinancial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP) and also the fact that the completion of the convergence process is expected in the second half of financial year 2011.

In Europe, IFRS gained significance from January 1^st, 2005, when all listed companies in the European Union had to prepare consolidated financial statements in accordance with IFRS.

In Romania, applying IFRS in the Romanian Banking System was requested by the International Monetary Fund and the European Union, as part of the financing agreements concluded with the Romanian authorities. A number of other European countries require credit institutions to prepare IFRS individual financial statements (for example, Italy, Portugal, Greece, and the Baltic states). As explained, the reason why there is so much emphasis on conversion of the banking system to IFRS is because comparability and transparency of financial statements prepared by credit institutions is imperative for stability.

 

Challenges

 

A. IFRS implementation context

Big changes are always difficult, but the current context emphasizes the challenge of the convergence process.

Time represents the first difficulty – there are only a couple of months until January 1^st, 2012 and, although the transition period started in 2009, many aspects such as the new chart of accounts, the prudential regulations and the tax aspects of IFRSimplementation have only recently been solved or are still in the development process. Solving these issues has generated extensive discussions and controversies between the three main players involved – credit institutions and the RomanianAssociation of Banks (ARB), the National Bank of Romania (NBR) and the Ministry of Public Finance (MFP). Furthermore, the difficult economic situation, reflected by the concentration of resources in monitoring credit portfolios and by the need to reduce expenses, makes it more difficult to find a balance between cost and the reliability of the solutions implemented by banks.

 

B. Financial-Accounting as pects

Conformity with IFRS requires the adoption of all applicable standards, but not all the standards will present the same challenges.

For the particularization of the financial-accounting aspects involved in IFRS conversion, we selected 6 areas which have a major impact on financial statements or whose implementation will require more resources. For this purpose, the next graphic illustrates the importance of applying IFRS: the horizontal axis represents the expected impact on the financial statements (i.e. on the profit and loss account and/or equity) and the vertical axis the implementation cost (represented mainly by the cost of the IT solutions). In addition, we have ended the chapter by discussing the general presentation requirements of the financial statements and by a short look towards the future.

1. Adjustments for the depreciation of financial assets
2. Recognition and valuation of financial instruments
3. Accounting treatment of investment securities
4. Revenue recognition
5. Deferred tax
6. Consolidation of Special Purpose Entities
7. Presentation of financial statements
8. Looking to the future

1. Adjustments for the depreciation of financial assets (IAS 39)

Adjustments for the depreciation of financial instruments are a field where the accounting, supervision and administration requirements interrelate. It is the area with the biggest accounting impact, but also the most exposed to value judgements and, as a consequence, the most open to debate.

The significant difference between the adjustments for depreciation of loans calculated on the basis of IFRS principles and the adjustments for depreciationof loans calculated on the basis of NBR applicable accounting regulations has probably been the most controversial aspect.

Besides the difficulty of adopting the “occurred loss” model, parameters and new concepts like the probability of loss and collective provisioning, all of which are challenging by themselves, the true challenge starts from the foundation of thismethodology. The provisioning methodology specified in IAS 39 is not normative, in opposition to the existing specifications of the National Bank of Romania included in Regulation no. 3/2009. The IFRS approach emphasizes professional judgementwhich is crucial in estimating many factors used in provisions calculation, which leads to a high degree of subjectivity. Provisions were named by the president of the ARB1 , Radu Gratian Ghetea, as “the apple of discord” in the trilateral negotiationsbetween the ARB, the NBR and the MFP. As such, the banks need to develop not only the methodologies which are in accordance with IFRS general principles, but also systems for provisions ratification (back testing, stress-testing, etc.) able to reduce or correct the element of subjectivity.

Romanian banks, used to the matrix calculation method specified in the statutory Romanian regulations, need also to understand that the IFRS methodology is alive and continuously changing. New information can become available and able to indicate the depreciation of a part of the portfolio or the need for an additional segmentation, parameters need to be permanently updated and, at the same time, banks need to establish the extent to which the historical reality matches with the actual context. Banks should permanently verify whether the parameters obtainedon the basis of historical data need to be adjusted to reflect recent developments more closely

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