Loss-free Valuation of the Banking Book

In the context of accounting under commercial law, the principles of proper accounting are also to be applied to interest-related transactions in the banking book of credit institutions. However, since credit institutions’ business activities in the banking book typically do not include 1:1 refinancing or interest rate risk hedging of lending transactions, an isolated analysis of individual transactions is generally not expedient for the purposes of internal risk and income controlling. Instead, the controlling is generally handled at the macro level for the banking book in its entirety as a refinancing network.

Before the German Accounting Law Modernization Act (BilMoG) entered into force, there was no market-induced valuation of the banking book for accounting purposes under commercial law due to a lack of explicit statutory regulation and the lack of possibilities for sufficiently precise measurement. The imparity-based individual valuation (in accordance with Section 252 (1) (3) in conjunction with (4) of the Commercial Code (HGB)) for transactions in the interest book was thus neglected with reference to the so-called “valuation convention” or “accounting convention.”

The commercial law requirements for determining any need for provisions in IDW RS BFA 3, which was adopted in its initial version in August 2012 and in a new version with various additions and clarifications in October 2017, were specified in more detail.

Dynamic Market Environment and Increasing Regulation

In particular, the current low interest rate environment and the resulting tense competitive conditions in the German banking sector with shrinking interest margins and corresponding reductions in earnings illustrate the need for the most precise controlling possible for the interest book. Accordingly, it is becoming increasingly important to determine any possibly existing excess liability, for which a provision must be set up in accordance with Section 249 (1) (1) Alternative (2) of the Commercial Code (HGB).

Last but not least, banking book management is increasingly becoming the focus of the supervisory authority and auditing bodies, for example due to the EBA guidelines for controlling interest rate risk in the banking book (“IRRBB”). Consequently, our clients often take the increased requirements as an opportunity to optimize economic controlling and (with a view to a rising interest rate environment) stabilize it sustainably.

Typical Issues in Loss-free Valuation of the Interest Book

Particularly due to the focus on internal controlling and the resulting need for consistency between accounting in accordance with the Commercial Code (HGB) and economic risk controlling, credit institutions are faced with various issues when implementing the requirements for loss-free valuation of the interest book in accordance with IDW RS BFA 3:

• Avoidance of unnecessary complexity by using a sliding scale
• Methodology option: Income-statement-oriented (periodic or period-related) or net cash value (static or time-related) approach
• Objectifiable and non-arbitrary separation of portfolios
• Definition of relevant business data and input parameters
• Result components from different technical perspectives: Cash flows, carrying amounts, cash values, risk/administrative/refinancing costs
• Modelling of certain contract or product constellations: Termination rights, negative interest conditions, fictitious expirations with indefinite interest or capital commitments, etc.
• Valuation: determination of the relevant discount curves
• Method concept for risk costs and administrative costs
• Method concept for refinancing costs and option to consider the refinancing effect of equity
• Avoidance of double counting of provisions for pending losses and risk costs

WTS Advisory as an Experienced Partner for Loss-free Valuation of the Interest Book

WTS Advisory offers you comprehensive services for all issues related to the loss-free valuation of the interest book. This allows you to benefit from our extensive experience in technical design, practical implementation and continuous validation and further development of tailor-made solutions for our clients:

• Industry expertise and benchmark know-how from projects with financial institutions of different sizes and with different technical circumstances
• Professional competence and experience in commercial law bank accounting and numerous projects for specialist design, implementation and optimization
• Methodological competence in the application of adequate approaches with consideration of cost-benefit aspects
• Interface competence of the relevant departments of accounting, risk controlling, financial controlling and treasury
   

If you are interested or have any questions, please contact us.