Application of International Accounting Standards to Australian Banks Geoff Steel Group Finance Commonwealth Bank of Australia 1 July 2003

2 The material that follows is a presentation of general background information about Australian banking activities current at the date of the presentation, 1 July It is information given in summary form and does not purport to be complete. It is not intended to be relied upon as advice to investors or potential investors and does not take into account the investment objectives, financial situation or needs of any particular investor. These should be considered, with or without professional advice when deciding if an investment is appropriate. Disclaimer

3 Why Change to IAS? Financial Reporting Council decision to adopt IAS by 1 January 2005 Increased globalisation of economies Consistency with European listed entities Probability of US aligning at a future point

4 Comparatives Financial year first published IAS data Australia - one year comparatives US SEC Registrants - all major four banks - two years comparatives Full retrospective application from 1 July 2003

5 Areas of Major Impact Financial instruments Business combinations Intangible assets Pension accounting Insurance contracts Performance Reporting  Goal is to minimise reported P&L volatility RULES NOT YET FINALISED

6 AASB Key Decisions Early adoption BIG BANG approach Piecemeal adoption is prohibited except for: AASB 1020 “Income Taxes” Share Based payments

7 Financial Instruments IASB objective: Recognition and measurement of all risks associated with financial instruments, i.e. interest rate, FX, credit risk Outcome: Prescriptive accounting rules based on designation of instrument. All derivatives on balance sheet. No new risks: Australian banks already manage and report the risks addressed by this standard

8 Four categories of financial instruments are identified, based on intention 1. Trading - Valuation method - fair value - Treatment consistent with current practice 2. Loans originated - Valuation method - cost - Most lending assets (including Interbank Receivables) will quality as this category - Treatment consistent with current practice Financial Instruments (continued)

9 3. Held to maturity - Valuation method - cost - Held to maturity have strict criteria to qualify. No sales, no hedging 4. Available for sale - “Available for sale” is a new category - Valuation method - fair value - Allows flexibility to sell assets - Movements in value transferred to new Equity Reserve - Profits on sale transferred from reserve to profit - Hedging permitted

10 Hedges/Derivatives All hedges are fair valued and brought on balance sheet All hedges must be dealt with external market Two types of hedges defined, with different accounting implications 1. Fair Value Hedges (fixed rates hedged into floating) - FV both derivative and hedged item - Correlation of hedges to be measured at least six monthly (80-125% effectiveness range) - Ineffective portion of hedge to P&L

11 Hedges/Derivatives (continued) 2. Cash Flow Hedges (floating rates hedged into fixed) - FV derivatives but not underlying instrument - FV changes taken to Equity Reserve, then recycled to P&L when hedged item impacts P&L - Ineffective portion of hedge to P&L

12 Equity Rules regarding definition of equity are more rigid - must be able to avoid redemption to be equity Less scope for hybrid instruments. Potential for technical breaches of debt covenants by some corporates APRA treatment not yet defined

13 Issues to be Addressed Available for Sale category “Trading” option Cash flow hedges easier to identify and maintain effectiveness Fair value hedges used where high degree of correlation ‘Macro hedging’ now permitted Prepayment risk causes hedge ineffectiveness

14 Other Financial Instrument Issues Effective yield includes capitalised external costs Derecognition of assets - securitisation Loan impairment provisions Embedded derivatives, e.g. debt instrument return linked to ASX equity index movement Systems requirements

15 Business Combinations & Intangible Assets Identifiable intangible assets on acquisition, e.g. core deposits, brand names - Finite or indefinite life No amortisation of goodwill Assess goodwill for impairment on “cash generating unit” / segment basis

16 Pension Accounting Defined benefit plans Recognise prepaid pension cost or fund surplus as asset Fluctuations in surplus / deficit taken to profit

17 Insurance Contracts Phase , Phase Insurance contract - exposure to significant insurance risk - Apply existing Australian GAAP Unit linked products - no exposure to risk - Apply IAS 39 - investment contracts - Only capitalise external costs or market value business

18 Performance Reporting Early stages of development Greater categorisation of “profit” - Financial - Non-financial All value movements through P&L - e.g. property revaluations Profit before re-measurements Re-measurements - e.g. increases in existing provisions, property revaluations, equity investments

Application of International Accounting Standards to Australian Banks Geoff Steel Group Finance Commonwealth Bank of Australia 1 July 2003