Prof. Jayanth R. Varma's Financial Markets Blog

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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation. This blog is currently suspended.

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Tue, 13 Apr 2010

IFRS in the Indian financial sector: Regulatory Capture?

A group constituted by the Ministry of Corporate Affairs with representation of all major financial sector regulators in India has approved a road map for the convergence to international accounting standards (IFRS) by insurance companies, banking companies and non-banking finance companies.

First of all, why should there be a different road map for the financial sector? Why not let financial entities be subject to the same road map as the rest of the corporate sector? The only plausible argument is that the most important change from Indian accounting standards to IFRS would be the treatment of financial instruments (IAS 39) and this impacts the financial sector more than any other sector.

But this argument is rather weak because there are other sectors which are disproportionately impacted by IFRS and there is no kid glove treatment for those sectors. The accounting treatment for agriculture for example changes quite substantially under IFRS. But agriculture does not have a powerful set of regulators protecting their regulatees while the financial sector does.

What I found even more interesting was the different treatment of insurance companies and banks within the financial sector itself. Insurance companies will adopt IFRS in 2012 while banks get an extra year. Is this because insurance companies do not stand to lose much from IFRS and might even stand to gain, while banks stand to lose a lot more?

If one looks only at the complexity of the transition to IFRS, it is not possible to argue that the transition is easier for insurance companies than for banks. Insurance companies too have large investment portfolios and they too will have to contend with all the complexities of IAS 39. In addition, there is an entire accounting standard (IFRS 4) for the insurance industry and IFRS 4 is by no means a model of simplicity. The insurance regulator (IRDA) has a 200 page report describing the implications of IFRS for Indian insurance companies.

Nor is it true that contemplated changes in IFRS will impact banks more and that therefore it makes sense for them to transition directly to the revised standards as and when they come out. IFRS 4 relating to insurance is explicitly described as Phase I of the IASB’s insurance project and Phase II promises drastic and fundamental changes in the accounting approach.

No, I do not see any strong argument why it is in the public interest for insurance companies to converge to IFRS a year ahead of banks. It is obvious however that it is in the interest of the banks themselves to postpone IFRS because of the stringent treatment of held to maturity investments. A cynic would say that regulators in every country and every sector are in danger of being captured by their regulatees.

I think this is a powerful reason for not mixing up regulatory capital and accounting capital. It would be nice if regulators could accept that accounting is for investors and agree to stay from interfering in this. Regulators are free to collect whatever data they want and define capital and profits in whatever way they want. They are free to ignore everything that the accountants put out. That would help make it easier for accounting standards to provide what is most relevant and useful for investors.

Posted at 14:02 on Tue, 13 Apr 2010     View/Post Comments (0)     permanent link