The broad consensus before the recent financial crisis was that the so called fair value
accounting (FVA) improves transparency contrary to the historical cost model. Since 2008 the
discussion has been on the root cause of the crisis which lessons can be gleaned from it and
how making the same mistakes again can be avoided. Basel III was implemented in order to
improve the regulatory environment and was the response of regulators and politicians to public
pressure and suspicions raised by the bail out programmes for banks. Consequently an until
then inconceivable number of new regulations and regulatory bodies were introduced. FVA was
also blamed as part of the cause of the recent financial crisis. Available-for Sales (AfS)
securities represent a major component of bank balance sheet asset. Gains and losses of
AfS-positions are recorded within the Other Comprehensive Income (OCI). The OCI includes items
which are not recognized (IAS 1.7) in income statements but increase or decrease a bank's
equity. The items also include income and expenses from Available-for-Sale positions (AfS) in
accordance with IAS 39. On October 13th 2008 an amendment to IAS 39 was published by IASB.
This amendment did authorize the reclassification of assets. This amendment clearly
demonstrates the influence of FVA on the value of assets of banks that apply IFRS. The main
objective of this book is to verify the influence of OCI and whether the new regulations
sufficiently capture this critical factor. Regulators should ensure that unrealized profits do
not result in a capital drain. One way to assure this is to make OCI subject to a prudential
filter and to deduct it from regulatory capital which was the case until CRR became effective
on January 1st 2014 (CEBS guideline 2004). Basel III is even less strict than Basel II in that
regard. Article 26(1) CRR clearly states that CET1 items must be recognized only in case they
are really available to the financial institution for unrestricted and immediate use to cover
risks or losses as soon as these occur. Nevertheless with the introduction of the CRR the
prudential filter for positions that caused the financial crisis and led to poor capitalization
of banks was not strengthened but actually removed. At present CRR does not envisage any
filter for unrealized gains parked in OCI.
