Blog Post

Effects of IFRS on Korean banks, and future prospects

Korean firms’ business activities, such as risk management and foreign investment, have been affected by the obligation since 2011 to adopt International Financial Reporting Standards (IFRS). Korean banks may need to reshape their credit-rating models and enhance their loan-collection systems to prepare for further changes in loan-loss accounting. In addition, the financial authorities must provide […]

By: Date: May 11, 2012 Topic: Global Economics & Governance

Korean firms’ business activities, such as risk management and foreign investment, have been affected by the obligation since 2011 to adopt International Financial Reporting Standards (IFRS). Korean banks may need to reshape their credit-rating models and enhance their loan-collection systems to prepare for further changes in loan-loss accounting. In addition, the financial authorities must provide adequate guidelines to minimise discretionary accounting and organise regulatory acts in order to prevent false disclosure. 

Korea’s accounting standards, and the quality of financial information, have improved since the adoption of IFRS in 2011, but comparability between financial statements has declined.

  • IFRS was first adopted for listed companies in EU member countries in 2005. Since then, it has expanded rapidly across the globe, leading Korea to also adopt the standards for its listed corporate bodies and most financial companies.
  • IFRS regards consolidated financial statements as the main financial statements, and greatly expands disclosure requirements. Therefore, transparency in accounting standards and the quality of overall financial information have been upgraded. However, it is commonly recognised that the comparability of financial statements has declined because unlike the previous Korean GAAP (K-GAAP) standards, IFRS follows ‘principle-based standards’.

The introduction of IFRS benefited Korean banks by reducing the requirement to make an allowance for bad debts, but it has become more difficult for Korean banks to dispose of non-performing loans (NPL) through securitisation. And the adoption of IFRS has increased the exposure of Korean banks’ profits to the fluctuation of foreign exchange rates.

  • Under IFRS, bad debts remain on the books even if the bank sells the debt to a third party through securitisation – where the bank is connected to the liquidised asset through subordinated debt or payment guarantee [1].
  • Direct investment in a foreign subsidiary is classified as a non-monetary asset where there is no profit and loss with the fluctuation of the exchange rate. On the other hand, the investment source is financed with monetary liabilities, which are subject to foreign exchange risk if there is no hedging [2].
  • Impairment of marketable securities directly affects net profit under IFRS, thus requiring enforcement of risk management on those securities.

In order to effectively utilise financial information for loan evaluation, Korean banks need to reshape their credit-rating models and re-educate loan officers.

  • Annual IFRS financial statements are being disclosed for the first time in the first half of 2012. So, use of financial information based on the previous K-GAAP standard will no longer be comparable.
  • Also, a wide range of footnotes needs to be effectively utilised in the process of credit-rating evaluation.

Korean banks will have to enhance their loan-information infrastructure in order to prudently adapt to further changes in the accounting standard for loan losses.

  • Unlike the previous incurred-loss model, the expected-loss model of ‘IFRS 9 Financial Instruments’, which may be adopted in 2015, distributes credit loss provisions until maturity. So, a database of loan loss information needs to be developed in order to reflect long-term loss as a whole. 

Empirical studies [3] of 90 EU banks showed that the cost of equity capital rose after the mandatory adoption of IFRS in 2005. But, countries with efficient legal enforcement [4], such as Belgium, Denmark, Germany and the United Kingdom did not see an increase in their capital costs.

  • This indicates that prevention of false reports through legal enforcement rather than increased disclosure requirements is more effective in alleviating information asymmetry.

In an effort to embed IFRS in the banking sector, the authorities should provide more transparent disclosure guidelines, and enhance enforcement to prevent false disclosure.

  • Since the intent of IFRS is to allow a certain degree of discretion to individual firms, it would be better to provide examples of bad adoption, rather than to specify rules on how to handle each footnote.

  1. For this reason, during 2010-11, domestic banks did not use the method of securitisation when disposing of insolvent obligations. This led to an energising of the NPL market in Korea.
  2. Monetary assets include cash, loans, deposits, corporate bonds, etc, while non-monetary assets include stock investments, inventories, etc. If foreign assets or debts fall into monetary items, then they are evaluated using the exchange rate at the end of the fiscal year, but if they fall into non-monetary items, they are evaluated mostly using historical prices. In particular, as Korean banks expand their investments in Southeast Asia, their cross-currency exchange risk is increasing.
  3. Hwang, L., J. H. Suh and S. Yim (2011) ‘The Impact of Mandatory IFRS Adoption on the Cost of Equity Capital: An Empirical Analysis of European Banks’, KIF Working Paper, December.
  4. For more information, see La Porta, R., F. López-de-Silanes, A. Shleifer, R. Vishny (1998) ‘Law and Finance’, Journal of Political Economy 106, 1113-1155.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.


Warning: Invalid argument supplied for foreach() in /home/bruegelo/public_html/wp-content/themes/bruegel/content.php on line 449
View comments
Read article More on this topic

Opinion

Sticks and carrots from China’s leadership to Chinese banks

The takeaway from the 13th National People's Congress (NPC) is clear: under the current economic downturn, Chinese authorities will do whatever it takes to support the real economy. Alicia García Herrero and Gary Ng reflect on the "sticks snd carrots" approach to Chinese banks.

By: Alicia García-Herrero and Gary Ng Topic: Global Economics & Governance Date: March 21, 2019
Read about event

Upcoming Event

Mar
27
15:00

Changing relationships between Europe and Africa in the face of technological development – can digitalisation, AI and the platform economy help bridge the gap?

This event will look at digitalisation in Europe and Africa and how this is changing the relationship between the two continents

Speakers: Masood Ahmed, Charles Kenny, Susan Lund, J. Scott Marcus and Amolo Ng’weno Topic: Global Economics & Governance, Innovation & Competition Policy Location: 1 Abbey Gardens, Great College Street, London, SW1P 3SE
Read about event More on this topic

Past Event

Past Event

The trade crisis: good and bad scenarios and the EU's response

What role will the EU play in the resolution of the global trade crisis?

Speakers: Uri Dadush, Maria Demertzis and Denis Redonnet Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 20, 2019
Read article More on this topic More by this author

Opinion

China’s debt is still piling up – and the pile-up is getting faster

With looser monetary policy, China's policymakers hope to encourage banks to lend more to the private sector. This seems to imply a change from the deleveraging drive begun in mid-2017. Although this should be good news for China's growth in the short term, such a continued accumulation of debt cannot but imply deflationary pressures and a lower potential growth further down the road.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: March 19, 2019
Read article Download PDF More on this topic

External Publication

Towards EU-MENA shared prosperity

This joint publication collects the papers produced as part of the third collaboration between Bruegel and the Policy Center for the New South (PCNS). Within the theme “Towards EU-MENA Shared Prosperity”, the two organisations launched a “Platform for Advanced & Emerging Economies Policy Dialogue” in Rabat on 1 April 2016, addressing issues of common interest in the Mediterranean and the MENA Region.

By: Abdelaziz Ait Ali, Uri Dadush, Yassine Msadfa, Yana Myachenkova and Simone Tagliapietra Topic: Global Economics & Governance Date: March 14, 2019
Read about event More on this topic

Past Event

Past Event

Law and macroeconomics: legal responses to recessions

This event will feature an academic lecture on the use of law as a macroeconomic tool.

Speakers: Yair Listokin and Maria Demertzis Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 12, 2019
Read article More by this author

Opinion

The case for green realism

The transition to a carbon-neutral economy is bound to make us worse off before it makes us better off, and the most vulnerable segments of society will be hit especially hard. Unless we acknowledge and address this reality, support for greening the economy will remain shallow and eventually wane.

By: Jean Pisani-Ferry Topic: Energy & Climate, Global Economics & Governance Date: March 7, 2019
Read article More on this topic More by this author

Blog Post

Russia's foreign policy does not help its economic modernisation

In the highly interdependent modern world, a country’s economy and its foreign policy are strongly linked. A country’s foreign-policy ambitions should correspond to its economic potential, but Russia’s over-ambitious foreign ventures have exacerbated the negative effects of the numerous economic headwinds it faces.

By: Marek Dabrowski Topic: Global Economics & Governance Date: March 6, 2019
Read article More on this topic More by this author

Opinion

Tense transatlantic relations put EU in tough spot

The global multilateral system is being challenged by the US and China, which prompts the EU to rethink how well it can compete in the world.

By: Maria Demertzis Topic: Global Economics & Governance Date: March 5, 2019
Read article More on this topic More by this author

Blog Post

The possible Chinese-US trade deal

The future of Sino-American relations after the incoming end of trade talks between Beijing and Washington. We review opinions in the English-speaking blogosphere on the likely content of the deal and the message this agreement sends to the world.

By: Jan Mazza Topic: Global Economics & Governance Date: March 4, 2019
Read article More on this topic More by this author

Opinion

China's strategy: Growth, alliances, and tech acquisition

Despite the pause in the US-China trade war, the US and China are strategic competitors, and will continue to be so for the foreseeable future. China realizes that there is little room to settle long-term disputes and, as a result has shifted towards a strategy that focuses on sustaining growth at any cost, expanding alliances, and advancing its technology.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: February 27, 2019
Read article More by this author

Blog Post

The Economists’ Statement on Carbon Dividends and the Green New Deal

In the last month two prominent policy proposals that aim to combat climate change have been presented in the United States. The Green New Deal calls for the deployment of substantial government resources to combat climate change. The Economists’ Statement on Carbon Dividends, suggests a market-based and budget-neutral approach through a carbon tax. Michael Baltensperger reviews reactions to both.

By: Michael Baltensperger Topic: Energy & Climate, Global Economics & Governance Date: February 25, 2019
Load more posts