1 1 Behavioural changes of financial institutions in response to changes in accounting Gérard GIL Group Chief Accountant Officer Group BNP Paribas Behavioural changes of financial institutions in response to changes in accounting Gérard GIL Group Chief Accountant Officer Group BNP Paribas Workshop on Accounting Risk Management and prudential regulation Basel, November 2005

2 2 Workshop on Accounting Risk Management and Prudential Regulation Basel, 11 – 12 November 2005 Workshop on Accounting Risk Management and Prudential Regulation Basel, 11 – 12 November Behavioural changes of financial institutions resulting from changes in accounting A relatively new issue in Europe Little evidence based on specific studies IFRS : a real life case study External observations make it difficult to appreciate the real motivation of a change in business behaviour 1.Behavioural changes of financial institutions resulting from changes in accounting A relatively new issue in Europe Little evidence based on specific studies IFRS : a real life case study External observations make it difficult to appreciate the real motivation of a change in business behaviour

3 3 Workshop on Accounting Risk Management and Prudential Regulation Basel, 11 – 12 November 2005 Workshop on Accounting Risk Management and Prudential Regulation Basel, 11 – 12 November Possible reflexions following Anne Beatty study Academic study demonstrating that the interaction between accounting and business behaviour is not only an intuition Accounting is not just a « language », it also conditions or influences - Business behaviour - Social behaviour - Competition between companies and « economies » In a profit driven world, management is concerned by the way results of operations are presented and interpreted by the market - Accounting rule is business rule 2.Possible reflexions following Anne Beatty study Academic study demonstrating that the interaction between accounting and business behaviour is not only an intuition Accounting is not just a « language », it also conditions or influences - Business behaviour - Social behaviour - Competition between companies and « economies » In a profit driven world, management is concerned by the way results of operations are presented and interpreted by the market - Accounting rule is business rule

4 4 Workshop on Accounting Risk Management and Prudential Regulation Basel, 11 – 12 November 2005 Workshop on Accounting Risk Management and Prudential Regulation Basel, 11 – 12 November A few illustrations of changes in behaviour as a result of the adoption of IFRS Accounting changes may or have affected - The offer of financial products - The social behaviour of a company - Competitive distorsion - The underlying rationale of operations or strategies 3.A few illustrations of changes in behaviour as a result of the adoption of IFRS Accounting changes may or have affected - The offer of financial products - The social behaviour of a company - Competitive distorsion - The underlying rationale of operations or strategies

5 5 Workshop on Accounting Risk Management and Prudential Regulation Basel, 11 – 12 November 2005 Workshop on Accounting Risk Management and Prudential Regulation Basel, 11 – 12 November Accounting changes may affect the offer of financial products - Markets have an adverse attitude to the volatility of the profit and loss account - A full fair value model applied to the banking book would create fake volatility in the P/L in the context of demand deposit hedging - Banks may reduce their fixed rate loans exposure, and pass to their clients more variable rate exposure (e.g. mortgage loans, investment loans) - Limitation of fixed rate loans in a proportion acceptable with volatility expectation - Major change for the banking industry in the context of a fixed rate economic environment An opportunity for banks not required to comply with IFRS or non-listed 3.1 Accounting changes may affect the offer of financial products - Markets have an adverse attitude to the volatility of the profit and loss account - A full fair value model applied to the banking book would create fake volatility in the P/L in the context of demand deposit hedging - Banks may reduce their fixed rate loans exposure, and pass to their clients more variable rate exposure (e.g. mortgage loans, investment loans) - Limitation of fixed rate loans in a proportion acceptable with volatility expectation - Major change for the banking industry in the context of a fixed rate economic environment An opportunity for banks not required to comply with IFRS or non-listed

6 6 Workshop on Accounting Risk Management and Prudential Regulation Basel, 11 – 12 November 2005 Workshop on Accounting Risk Management and Prudential Regulation Basel, 11 – 12 November Accounting changes have affected the social behaviour of companies Banks are disadvantaged through paying differed bonuses in the form of shares (IFRS 2) rather than of cash for past performance of traders Caracteristics of stock options need to be modified to reduce the P&L charge. The provision of such benefits may well be reduced globally Healthcare scheme based on the principle of « solidarity between generations » had to be modified in France to avoid being qualified as defined benefit plans in respect of retirees 3.2Accounting changes have affected the social behaviour of companies Banks are disadvantaged through paying differed bonuses in the form of shares (IFRS 2) rather than of cash for past performance of traders Caracteristics of stock options need to be modified to reduce the P&L charge. The provision of such benefits may well be reduced globally Healthcare scheme based on the principle of « solidarity between generations » had to be modified in France to avoid being qualified as defined benefit plans in respect of retirees

7 7 Workshop on Accounting Risk Management and Prudential Regulation Basel, 11 – 12 November 2005 Workshop on Accounting Risk Management and Prudential Regulation Basel, 11 – 12 November Accounting changes may create competitive distorsion Business combinations : generalisation of the purchase accounting method gives an advantage to already concentrated industries 1. Pooling of interest have given an incentive to growth to some industries in certain economies 2. Purchase accounting method favours the « big » players Trading : synthetic instruments marked to model New Day One profit rules lead to differing of profits Development of strict rules to qualify observable parameters may transfer business to non regulated industry (hedge funds) Tailor made synthetic instruments (CDO’s, Power Duals…) may become less secure for investors 3.3 Accounting changes may create competitive distorsion Business combinations : generalisation of the purchase accounting method gives an advantage to already concentrated industries 1. Pooling of interest have given an incentive to growth to some industries in certain economies 2. Purchase accounting method favours the « big » players Trading : synthetic instruments marked to model New Day One profit rules lead to differing of profits Development of strict rules to qualify observable parameters may transfer business to non regulated industry (hedge funds) Tailor made synthetic instruments (CDO’s, Power Duals…) may become less secure for investors

8 8 Workshop on Accounting Risk Management and Prudential Regulation Basel, 11 – 12 November 2005 Workshop on Accounting Risk Management and Prudential Regulation Basel, 11 – 12 November Accounting changes may lead to unrational behaviour Accounting rules induce banks to develop and engage in practices solely because of the accounting qualification implications 1. Cash flows hedge of demand deposits need a variable rate asset portfolio 2. If such portfolio does not naturally exist, it has to be artificially created Accounting rules may result in companies not hedging their future risks - Future turnover in a foreign currency needs to be protected against exchange rate fluctuations. Accounting of the change in value of the protection in an inadequate period may discourage the hedging strategy 3.4 Accounting changes may lead to unrational behaviour Accounting rules induce banks to develop and engage in practices solely because of the accounting qualification implications 1. Cash flows hedge of demand deposits need a variable rate asset portfolio 2. If such portfolio does not naturally exist, it has to be artificially created Accounting rules may result in companies not hedging their future risks - Future turnover in a foreign currency needs to be protected against exchange rate fluctuations. Accounting of the change in value of the protection in an inadequate period may discourage the hedging strategy

9 9 Workshop on Accounting Risk Management and Prudential Regulation Basel, 11 – 12 November 2005 Workshop on Accounting Risk Management and Prudential Regulation Basel, 11 – 12 November 2005 CONCLUSION Empirical evidence of the influence of accounting on business behaviour is demonstrated Standard setters cannot disregard the consequences of standard changes on economical behaviour changes Accounting standards « condition » economic models Universal accounting standards would lead to uniformization of accounting models What is the role of accounting standards ? - Shouldn’t they be adapted to the regional economic model ? CONCLUSION Empirical evidence of the influence of accounting on business behaviour is demonstrated Standard setters cannot disregard the consequences of standard changes on economical behaviour changes Accounting standards « condition » economic models Universal accounting standards would lead to uniformization of accounting models What is the role of accounting standards ? - Shouldn’t they be adapted to the regional economic model ?