IFRS and Basel 2: the Italian experience 1 1 Luca Giannini ABI - Italian Banking Association Luca Giannini, ABI - Italian Banking Association IFRS and Basel 2: the Italian experience

IFRS and Basel 2: the Italian experience 2 2 Luca Giannini ABI - Italian Banking Association Agenda 1. IAS/IFRS and Basel 2: general context 2. ABI: IAS Project and Basel Project 3. The adoption of IAS/IFRS and Basel 2 in Italy 4. IAS/IFRS impacts 5. Conclusions

IFRS and Basel 2: the Italian experience 3 3 Luca Giannini ABI - Italian Banking Association 1. IAS/IFRS and Basel 2: general context different objective - Basel: Stability of the banking sector - IAS/IFRS: Performance report to shareholders on current period through to reporting date different effective date - Basel: from IAS/IFRS: from 2005

IFRS and Basel 2: the Italian experience 4 4 Luca Giannini ABI - Italian Banking Association Lisbon European Council March 2000 European Commission (EC) Communication entitled "The EU's Financial Reporting Strategy: The way forward“ IAS Regulation (EC)1606/2002 EC adopts IAS/IFRS exiting (“endorsement” mechanism”) European quoted enterprises apply IAS/IFRS in their Consolidated Financial Statements MarchJuneJuly IAS/IFRS The Accord Implementation Group (AIG) developed a set of principles for enhancing the efficiency of the approval process for international banking groups The Basel Committee published the “International Convergence of Capital Measurements and Capital Standards: A Revised Framework Basel II” The Basel Committee issued an updated version of the framework The Basel Committee issued a comprehensive version of the Basel II Framework, solely as a matter of convenience to readers The European Commission published the Capital Requirements Directives (Directive 2006/48/EC and Directive 2006/49/EC) Basel AugustJune 2005 NovemberJune 2006 January 1. IAS/IFRS and Basel 2: general context

IFRS and Basel 2: the Italian experience 5 5 Luca Giannini ABI - Italian Banking Association ABI Basel 2 activities 2. ABI: IAS Project and Basel Project join more than 30 meeting at EBF level send 16 Position Papers to the European Commission, the Basel Committee and the Bank of Italy propose 34 amendments to the CRD (7 by the means of Italian parliamentary) organize training courses with almost 500 participants from 140 companies organize more than 100 seminars with more than 3500 participants issue a guideline on the PD and LGD estimation create a national database for the operational losses (DIPO) The work done enabled ABI to: In order to deal with the transposition of the Basel 2 framework, from 2001 ABI set out 5 working groups and 5 sub-working groups, involving more than 250 banking experts in more than 60 meetings.

IFRS and Basel 2: the Italian experience 6 6 Luca Giannini ABI - Italian Banking Association Influence and manage the introduction of the IAS/IFRS in the Italian legislation Influence and manage the interpretation of the IAS/IFRS in the Italian context Promote the adoption of the IAS/IFRS Support the Italian Banking Sector in the implementation of the IAS/IFRS In the 2002, ABI started a Project in order to: 2. ABI: IAS Project and Basel Project IAS ABI Project

IFRS and Basel 2: the Italian experience 7 7 Luca Giannini ABI - Italian Banking Association The Structure of IAS Project a) Steering Committee b) Project Manager c) Planning Manager d) Working Groups Steering Committee is composed of representatives of ABI, banks and Universities. It ’ s committed to govern the Project and is supported to achieve his aims by working groups. On January 2004, working groups were composed of: 148 banking experts, from 42 banks of 26 banking groups; 21 auditing experts from the big auditing firms. There were 8 working groups and 23 operating units. 2. ABI: IAS Project and Basel Project IAS ABI Project

IFRS and Basel 2: the Italian experience 8 8 Luca Giannini ABI - Italian Banking Association IAS Project: ABI activities 2. ABI: IAS Project and Basel Project In order to deal with the application of IAS/IFRS, from 2002 the work done enabled ABI to: - send 33 Position Papers to the European Commission, IASB, EFRAG, Basel Committee on Banking Supervision, Bank of Italy, National Standard Setter; - join more than 45 meetings at European and International level (EBF Accounting Working Group and IBFED Accounting Working Group); - join more than 180 meetings at National level.

IFRS and Basel 2: the Italian experience 9 9 Luca Giannini ABI - Italian Banking Association Conventions (7); Seminar and Training courses (45); IAS ABI BlueBook (39); “Soluzioni IAS ABI” (36). IAS Project’s outputs for ABI associates: Other subjects interested to IAS Project’s outputs: Ministry of Finance; Universities; National Standard Setter; Other Lobbying Associations. IAS ABI Project 2. ABI: IAS Project and Basel Project

IFRS and Basel 2: the Italian experience 10 Luca Giannini ABI - Italian Banking Association IAS Regulation (EC)1606/2002: Legislative Decree 28th February 2005, n.38 (IAS Decree) IAS/IFRS Basel 2 New regulations for the prudential supervision of banks: Bank of Italy Circular n. 263 of 27 December 2006 Adjustment of the accounting directives to the IAS/ IFRS: - Directive 2001/65/EC of amending Directives 78/660/EEC, 83/349/EEC and 86/635/EEC: partially adopted with Legislative Decree 30th December 2003, n.394 Adjustment of the accounting directives to the IAS/ IFRS: - Directive 2003/51/EC (amending Directives 78/660/EEC, 83/349/EEC, 86/635/EEC and 91/674/EEC on the annual and consolidated accounts): Enforced only for obligatory parts (Legislative Decree 2nd February 2007, n.32) 3. The adoption of IAS/IFRS and Basel 2 in Italy

IFRS and Basel 2: the Italian experience 11 Luca Giannini ABI - Italian Banking Association Basel 2 adoption: 2007 The CRD regulations take effect as from 1 January However, the CRD allows banks and banking groups to continue to observe the previous supervisory rules until 1 January 2008 (CRD Transitional provisions, Article 152). Such Transitional provisions intend to permit each intermediary to gradually implement the advanced methodologies and processes. Exception: CRD Transitional provisions exclude the rules on the calculation of the supervisory capital. As a result, Bank of Italy stated that the new provisions regarding supervisory capital shall be applicable immediately. Most of the Italians banks decided to continue to observe the previous supervisory rules until 1 January The adoption of IAS/IFRS and Basel 2 in Italy

IFRS and Basel 2: the Italian experience 12 Luca Giannini ABI - Italian Banking Association Basel 2 adoption: 2008 onwards Banks may choose between two methodologies for calculating their capital requirement: 1. the standardized approach, which is a development of the system established in the 1988 Capital Accord, and 2. the IRB approach. Under the IRB, the sensitivity of the standardized approach is enhanced by means of increased segmentation of exposures and the use of ratings issued by export credit agencies (ECAs) or specialized external credit assessment institutions (ECAIs) recognised for this purpose by the supervisory authorities. Credit risk Banks my choose between a number of methods to calculate the capital requirements for the risks ruled in the CRD: 3. The adoption of IAS/IFRS and Basel 2 in Italy It creates a more favourable regulatory treatment of retail exposures, which captures the effective risk of this portfolio. The new framework also establishes comprehensive rules governing credit risk mitigation (CRM) and securitizations.

IFRS and Basel 2: the Italian experience 13 Luca Giannini ABI - Italian Banking Association Basel 2 adoption: 2008 onwards The capital requirement can be calculated using: 1.a standardised approach or 2.an internal models approach, subject to compliance with organizational and quantitative requirements and authorization by the supervisory authorities. Market risk The most significant changes regard the establishment of specific organizational requirements for the supervisory of the trading book. 3. The adoption of IAS/IFRS and Basel 2 in Italy

IFRS and Basel 2: the Italian experience 14 Luca Giannini ABI - Italian Banking Association Basel 2 adoption: 2008 onwards The CRD envisages three methods for calculating the requirements: 1. Basic Indicator Approach (BIA). The requirement is calculated by multiplying an indicator of a bank's volume of business, gross income, by a specified factor. 2. Standardized Approach. A regulatory factor is applied for each of eight lines of business. 3. Advanced Measurement Approach (AMA). The amount of the requirement is determined using models based on operational loss data and other information gathered and processed by the bank. Operational risk Banks have to fulfill determined thresholds and a range of qualifying criteria in order to adopt the Standardized and Advanced Measurement Approaches. 3. The adoption of IAS/IFRS and Basel 2 in Italy

IFRS and Basel 2: the Italian experience 15 Luca Giannini ABI - Italian Banking Association The IAS Regulation require European companies listed in an EU securities market to prepare their consolidated financial statements in accordance with IFRSs starting with financial statements for financial year The IAS Regulation (EC)1606/2002 Require or permit IFRSs for unlisted companies Require or permit IFRSs in parent company (unconsolidated) financial statements Permit companies whose only listed securities are debt securities to delay IFRS adoption until 2007 The European IAS regulation applies not only to the 27 EU Member States but also to the three members of the European Economic Area (EEA) – Iceland, Liechtenstein, and Norway Options 3. The adoption of IAS/IFRS and Basel 2 in Italy IAS/IFRS adoption

IFRS and Basel 2: the Italian experience 16 Luca Giannini ABI - Italian Banking Association Listed companies, issuers of financial instruments widely distributed among the public, banks, stock broking companies, fund management companies, regulated financial institutions Consolidated financial statements Insurance companies Individual financial statements IFRSs optional from 2005 IFRSs compulsory from 2006 IFRSs compulsory from 2005 The use of options in the IAS Regulation in Italy (Legislative Decree 28th February 2005, n.38) Consolidated financial statements IFRSs not permitted in 2005 IFRSs compulsory from 2006 only for listed companies that do not prepare consolidated financial statements IFRSs compulsory from 2005 Individual financial statements 3. The adoption of IAS/IFRS and Basel 2 in Italy IAS/IFRS adoption

IFRS and Basel 2: the Italian experience 17 Luca Giannini ABI - Italian Banking Association Subsidiary and associated companies of the above companies, and other companies that prepare consolidated financial statements Small Companies preparing financial statements in abbreviated form IFRSs not permitted Consolidated financial statements IFRSs optional from 2005 Financial statements Individual financial statements 3. The adoption of IAS/IFRS and Basel 2 in Italy IAS/IFRS adoption The use of options in the IAS Regulation in Italy (Legislative Decree 28th February 2005, n.38)

IFRS and Basel 2: the Italian experience 18 Luca Giannini ABI - Italian Banking Association The use of options in the IAS Regulation in Italy (Legislative Decree 28th February 2005, n.38) Main drivers 3. The adoption of IAS/IFRS and Basel 2 in Italy IAS/IFRS adoption Technical forms of the accounts of banks and companies in the financial sector Limits to the earnings distribution Income taxes are based on reported accounting profit also for companies applying IAS/IFRS Principle of neutrality

IFRS and Basel 2: the Italian experience 19 Luca Giannini ABI - Italian Banking Association IAS 39: to resolve the carved-out endorsement Consistent application of the IAS/IFRS in Europe Convergence projects of the IAS/IFRS to US GAAP IAS/IFRS adoption: 2007 onwards 3. The adoption of IAS/IFRS and Basel 2 in Italy

IFRS and Basel 2: the Italian experience 20 Luca Giannini ABI - Italian Banking Association 1.Tool for supervisory information 2 Starting point for prudential supervisory requirements 3.Tool for market disclosure (Pillar 3) The different functions of the banking financial statement 3. The adoption of IAS/IFRS and Basel 2 in Italy

IFRS and Basel 2: the Italian experience 21 Luca Giannini ABI - Italian Banking Association The Circular n. 262 issued by the Bank of Italy on December 22, 2005 on the financial statements, emanated in line with IAS Decree, has the objective: to confer to the national regulation a character of best practice; to allow the connection with the activities of the Financial Reporting (FINREP); to match with the prudential supervision; to consider the national peculiarities and a level playing field. The different functions of the banking financial statement 3. The adoption of IAS/IFRS and Basel 2 in Italy

IFRS and Basel 2: the Italian experience 22 Luca Giannini ABI - Italian Banking Association Bank of Italy has established specific provisions ("prudential filters") to safeguard the quality of supervisory capital and attenuate the potential volatility associated with the adoption of the international accounting standards (IFRS/IAS). In Italy the "prudential filters“ are applied: a) Banking groups, from 31st December 2005; b) Banks, from 30th June These "prudential filters“ are in line with guidelines of the Basel Committee and of the CEBS (Committee of European Banking Supervisors). Regulatory Capital The new rules introduced by IAS/IFRS could affect the amount, the quality and volatility of bank’s capital. 4. IAS/IFRS impacts

IFRS and Basel 2: the Italian experience 23 Luca Giannini ABI - Italian Banking Association GENERAL PRINCIPLES: The general structure of the supervisory capital doesn’t change (e.g. T2 =< 100% of the T1). Nevertheless: - some capital components come less (for example: allowances for possible loan losses and general banking risk); - other components are included (for example: reserves of the financial assets available for sale). Regulatory Capital 4. IAS/IFRS impacts

IFRS and Basel 2: the Italian experience 24 Luca Giannini ABI - Italian Banking Association SPECIFIC PRINCIPLE: financial assets held for trading (HFT); fair value option (FVO); financial assets available for sale (AFS): specific treatment for the loans classified in this category; hedges; property, plant and equipment and investment property. Regulatory Capital 4. IAS/IFRS impacts

IFRS and Basel 2: the Italian experience 25 Luca Giannini ABI - Italian Banking Association The general rule for the transition to IAS (IFRS1, First-time Adoption of International Financial Reporting Standards) requires companies to proceeds, at the transition date, with the restatement of their balance sheets - prepared under national accounting standards – in accordance with IAS/IFRS rules. All the adjustments are recognized directly in the shareholders’ equity and not in the profits & loss accounts. First Time Adoption (FTA) 4. IAS/IFRS impacts

IFRS and Basel 2: the Italian experience 26 Luca Giannini ABI - Italian Banking Association Main IAS/IFRS impacts of First Time Adoption Loans Securitisation General banking reserve and general provisions Goodwill amortisation Investment property 4. IAS/IFRS impacts

IFRS and Basel 2: the Italian experience 27 Luca Giannini ABI - Italian Banking Association IAS/IFRS vs Basel 2 – Main convergences: i) The concept of “impairment IAS 39” is substantially equal to the concept of “default Basel”:  Basel: the obligor being 90 days past due on the obligation; and  IAS/IFRS: objective evidence of impairment connected to the missed payment. Loan Loss provisioning: IAS/IFRS vs. Basel 2 Basel 2 rules are finalized to calculate the capital adequacy through the capital charges. IAS/IFRS rules are oriented to show the financial performance based on the economic results. ii) For the collective measurement of performing loans can be used the new supervisory requirements, i.e., the probability of default (PD) and loss given default (LGD). 4. IAS/IFRS impacts

IFRS and Basel 2: the Italian experience 28 Luca Giannini ABI - Italian Banking Association IAS/IFRS vs Basel 2 – Main differences: i)Time - horizon: one year for Basel and residual maturity for IAS/IFRS. ii) The different concept of loss: expected loss for Basel and incurred loss for IAS/IFRS. iii) IAS/IFRS don’t require a validation of the internal process to assess from the Bank of Italy. Convergence of Basel II and IAS/IFRS is desirable because would reduce costs for banks and would improve the quality of financial statement. Loan Loss provisioning: IAS/IFRS vs. Basel 2 4. IAS/IFRS impacts

IFRS and Basel 2: the Italian experience 29 Luca Giannini ABI - Italian Banking Association The definition of new and international rules in the accounting and supervisory field is an occasion for each European country to put in place a revolution to improve the accountability, the competition and the efficiency of the financial intermediaries. Such a goal could be achieved putting in place a legislative framework that enable banks to: 1. prepare financial statement 2. calculate the capital requirements 3. calculate the taxable income 4. prepare the internal report for management purposes using a single set of data 5. Conclusions

IFRS and Basel 2: the Italian experience 30 Luca Giannini ABI - Italian Banking Association The starting point should be the accounting data determined using the IAS/IFRS, on solo and consolidated level. Then, a bank should be able to fulfill all the obligation related to the supervisory rules (COREP and FINREP) using the accounting data corrected using the prudential filter set out by the supervisory authority on the basis of the work done at CEBS. Finally, the accounting data should be the basis for the computation of the taxable income. In fact, international practices have developed several rules that permits to derive the taxable income for corporate income tax purposes from the financial accounting. 5. Conclusions