Did Basel III miss the point? The role of IFRS¿s Other Comprehensive Income during the financial crisis

The author has many years of professional experience in the banking industry. Currently, he works as a Chief Risk Officer at an international bank. Before his current position, he held various management positions and also served as a bank supervisor for three years. He obtained his Master s degree from Vienna University of Economics and Business and holds several other economic degrees.
The author never stopped thinking outside the box. In particular during his professional occupation as a bank supervisor he started to question whether Basel III can reach its goal or whether it missed the point by mainly putting pressure on small banks with conservative business models which had nothing to do with the root cause of the financial crisis - while softening the regulations for large significant banking groups with heavy trading book exposures. With this book, the author wants to spark the discussion whether this approach can improve the situation of the financial industry.

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Chapter 2.2 Impact of the amendment:
In order to prevent additional, but also in order to adjust already occurred losses, European banks reclassified financial instruments. For example, the Deutsche Bank AG reclassified financial assets in the amount of EUR 33 billion and therefore also avoided losses amounting to EUR 3.2 billion.
One of the reasons for introducing the amendment was harmonization between US GAAP and IFRS. However, such an option to reallocating assets retroactively never existed in this was in US GAAP. This provided banks the possibility to assess the impact on their financials and decide whether a reclassification will have a desirable effect. This is a major difference as it allowed banks to take an opportunistic approach and involved a form of accounting arbitrage.
The value determining the amortization cost was FV on the date of the executed reclassification, when the entity reclassified instruments out of HfT or AfS. In general, already recognized gains and losses cannot be reversed. All previous deductions to equity should remain. This was not valid for the reallocation, which had been made before November 1st 2008. In this case, a backdating of the value to July 1st 2008 was possible. Therefore, the IASB allowed to avoid charges to income and equity by revaluating assets from FVA to amortization costs.
Reclassifications had different impacts. In case assets were reclassified from HfT to amortization costs, the value of those assets remained stable over time. In particular, during declining markets in 2008, this meant an advantage as equity was no longer directly affected.
What is more interesting for this study is the second effect in case an HfT asset is reclassified to AfS. In that event, the asset is still priced at fair value. However, changes will - from that point on - be reported in OCI only. Therefore, the bank has the possibility to exclude the effect from the income statement.
What is most interesting in this regard is the reclassification from AfS in "Loans and Receivables "or in "Held to Maturity". Before the amendment was issued, each of these categories had its own criteria for a reason.
The asset had to obey with the definition of "Loans and Receivables" before it could be allocated to this category. As a result, fair value accounting was suspended for the reclassified assets and amortization costs used instead. The only impact of the amendment to IFRS 7 was the need for additional disclosure requirements for reclassified assets.
According to a sample taken from banks of the European Union, with a significant amount relevant assets on their balance sheets and which report their financials under IFRS , about 40% had reclassified assets [...].
3 THE ROLE OF OCI DURING THE RECENT FINANCIAL CRISIS:
3.1 OCI and the recent crisis:
The differences in FV from reclassified HfT to AfS assets were shifted from PnL to OCI. Therefore, it was mainly the financial reporting that changed as gains and losses of AfS positions affected the equity and were reported in OCI. The gains and losses from HfT positions are recognized within profit and loss accounts.
Presenting OCI items on performance statements, such as profit and loss accounts, increases judgement accuracy of financial statement users.
When considering the situation during the recent crisis, the OCI was of highly important because the reallocation was often applied to prevent banks from going into bankruptcy.