International Financial Reporting Standards (IFRS) are a set of accounting standards developed by the International Accounting Standards Board (IASB). They provide a common framework for financial reporting that aims to enhance comparability, transparency, and relevance of financial statements across different countries and industries. While IFRS does not specifically focus on risk management, it plays a significant role in the financial reporting practices of banks and financial institutions, which are essential components of effective risk management. Here’s how IFRS relates to risk management in banks and financial markets:
- Disclosure of Financial Instruments: IFRS requires banks and financial institutions to provide detailed disclosures about their financial instruments, including their nature, valuation, and associated risks. This includes information about credit risk, market risk, liquidity risk, and operational risk. By providing comprehensive and transparent information, IFRS enables stakeholders to assess the risks associated with financial instruments and make informed decisions.
- Impairment of Financial Assets: IFRS 9, the standard on financial instruments, introduced a new approach to impairment called the Expected Credit Loss (ECL) model. Under this model, banks and financial institutions are required to recognize expected credit losses on financial assets based on forward-looking information. The ECL model enhances the recognition of credit risk and encourages proactive risk management practices by requiring banks to assess and provide for potential future credit losses.
- Fair Value Measurement: IFRS provides guidance on the measurement of financial instruments at fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value measurement of financial instruments, including derivatives and investment securities, helps banks and financial institutions assess and manage market risk.
- Hedge Accounting: IFRS includes provisions for hedge accounting, which allows banks and financial institutions to mitigate the impact of market risks by designating certain financial instruments as hedges. Hedge accounting provides guidance on how to account for the offsetting effects of changes in fair values or cash flows of hedged items and hedging instruments. It enables banks to manage risks effectively and reduces volatility in financial statements.
- Consolidation of Special Purpose Entities (SPEs): IFRS provides guidance on the consolidation of special purpose entities, such as structured investment vehicles and other off-balance-sheet vehicles. The consolidation requirements aim to prevent banks and financial institutions from using such entities to hide risks or transfer assets to avoid disclosure or capital requirements.
- Disclosures on Risk Management Policies: IFRS requires banks and financial institutions to disclose information about their risk management policies, including the objectives, strategies, and processes for managing risks. This includes information on credit risk management, market risk management, liquidity risk management, and other relevant risk management practices. These disclosures enhance transparency and enable stakeholders to evaluate the effectiveness of risk management practices.
It’s important to note that while IFRS provides guidance on financial reporting and disclosures related to risk management, it does not prescribe specific risk management practices or methodologies. The responsibility for implementing effective risk management practices lies with the banks and financial institutions themselves, and they may adopt additional risk management frameworks and methodologies beyond what is required by IFRS.
