Banks should make a careful judgement on the value of their illiquid assets, rather than rely on current market prices to determine a fair price, international banking supervisors said "Determining fair value in a market that has become inactive depends on the facts and circumstances and may require the use of significant judgment," said the Basel Committee on Banking Supervision in recommendations published late Wednesday.
The valuation of illiquid assets has become a key issue in recent months, as banks sought to put a price on their holdings, even when the assets were no longer tradable because markets had frozen up. In order to reflect market conditions, banks have had to post huge writedowns on their assets in each quarter. In turn, banks had to seek fresh capital from shareholders in order to balance their books.
In its new guidelines destined for banks and regulators, the Basel Committee said even though a bank should take into account market prices in the valuation process, it "does not conclude automatically that any transaction price is determinative of fair value." Instead, a bank should apply systems of valuation that would have been put in place even during the normal functioning of the markets.
Even if "third parties" are used in the valuation process, the management of the bank should not be relieved of its "oversight responsibility to ensure appropriate fair valuations," the supervisors underlined. The Basel Committee, which assembles national central bankers and regulators, first published a draft of these guidelines last November. It followed action taken by European leaders in October to suspend so-called "mark-to-market" accountancy rules in order to stabilise bank balance sheets.
In early April, the US accounting industry also agreed to revamp the "mark to market" accounting standard. These rules had been tightened after a series of corporate scandals including at energy giant Enron, which used unrealistic figures to inflate its worth.
Some analysts believe that by forcing banks to recognise losses immediately during the current economic and financial crisis, the rules worsened the situation by requiring financial institutions to raise new capital to offset losses.
This squeezed the ability of banks to make new loans to boost economic activity. The Basel-based committee presided by Dutch central bank president Nout Wellinck is an advisory and co-operation body that brings together official banking supervisors from 20 countries, including the world's major financial centres.