New derivatives valuation norms to sway banks' bottomlines

CA Nikita | Last updated: 01 September 2007

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Bank balance sheets may turn more volatile on account of the new accounting rules that would change the way derivatives are valued.

The central bank has set up a sub-group to look at implementation of Accounting Standard 30 (AS 30), which pertains to recognition and measurement of financial instruments. AS 30 is the Indian equivalent of the global accounting standard IAS 39.

Financial instruments are essentially contracts that are recorded as a liability on the books of one entity and an asset on the book of the counterparty to the contract. When banks were asked to revalue their bond portfolios regularly by marking them to market, their balance sheet witnessed huge swings with several hundred crores being wiped out with a one percentage point rise in rates.

IAS 39 aims to take this valuation exercise a step further by changing the way banks value derivatives on their books. The global standards apply to complex derivative financial instruments such as call options, put options, forwards, futures, and swaps. Valuations of derivatives are a much more tricky issue because they allow banks to take positions on future price movements on low cost or no cost at all.

The sub-committee constituted by RBI has representation from the banking industry. “IBA has a representation in the sub-group, however, the group is yet to conduct its first meeting,” said Indian Banks’ Association Chief Executive HN Sinor.

India has committed to adhere to international accounting standards by 2011. However, bankers feel that AS 30 will be among last to get implemented. This is because some of the financial instruments AS 30 looks at are not yet in use in the Indian market.

Bank exposure to derivatives has risen greatly in recent years. However, besides financial instruments, IAS 39 also pertains to contracts that are not financial instruments but have similar characteristics.

In other words any contract, even for non-financial items, can be governed by IAS 39 if the deal can be settled in cash instead of actual delivery.

Internationally, the roll out of IAS 39 was not without controversy. The International Accounting Standards Board and the European Union were for long embroiled in a dispute over the mark-to-market feature of the new standards.