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 about event

Past Event

Past Event

A conversation with Jin Liqun, president of AIIB

We were pleased to host Jin Liqun, the president of Asian Infrastructure Investment Bank at Bruegel.

Speakers: Sven Biscop, Guntram B. Wolff and Jin Liqun Topic: Finance & Financial Regulation, Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: January 22, 2018
Read article More on this topic More by this author

Blog Post

The financial side of the productivity slowdown

Scholars have devoted much research to the “productivity puzzle” that has emerged after the crisis, and some are investigating the role of financial frictions and capital allocation in relation to this phenomenon.

By: Silvia Merler Topic: Global Economics & Governance Date: January 22, 2018
Read article More on this topic More by this author

Opinion

It is safer to rely on what we know, rather than speculate on what may happen

"Does the Conventional Wisdom About Productivity Need To Be Reconsidered?" On a recent collection of opinions, Marek Dabrowski was invited to give his views on this question.

By: Marek Dabrowski Topic: Global Economics & Governance Date: January 16, 2018
Read article More on this topic More by this author

Blog Post

A few good (wo)men – on the representation of women in economics

Last week, the American Economics Association Annual Meetings held a session on Gender Issues in Economics and later announced that a new code of professional conduct is in the pipeline. In this blogs review we revise the recent contributions on female representation and perception in economics.

By: Inês Goncalves Raposo Topic: Global Economics & Governance Date: January 15, 2018
Read article More on this topic More by this author

Blog Post

Abenomics, five years in

Five years have passed since Japan’s Prime Minister Shinzō Abe was elected in 2012 and started “Abenomics”, a macroeconomic package based upon the “three arrows” of monetary easing, fiscal stimulus and structural reforms. After five years, has Abenomics worked? We review recent opinions.

By: Silvia Merler Topic: Global Economics & Governance Date: January 8, 2018
Read article More by this author

Opinion

China Fails to Woo U.S. With Financial Sector Opening

China's recent announcement of reforming its financial market has received little enthusiasm from the U.S. despite its potential benefits. The lack of a clear agenda regarding its economic rival has pushed the Trump administration to minor any significant progress of China's reform, and to maintain focus on strategic issues.

By: Alicia García-Herrero Topic: Finance & Financial Regulation, Global Economics & Governance Date: January 5, 2018
Read article

Opinion

Chinese banks’ improved asset quality cannot hide other phantoms

The recent improvement in asset quality cannot mask other growing concerns in China’s banking sector. Beyond liquidity concerns, other structural issues such as low profitability and insufficient generation of organic capital, are emerging.

By: Alicia García-Herrero and Gary Ng Topic: Finance & Financial Regulation, Global Economics & Governance Date: December 20, 2017
Read article More on this topic More by this author

Blog Post

The Republican Tax Plan (2): The debate rumbles on

Reactions to the Republican tax plans continue, concentrating on different aspects of the proposed legislation. We review the latest contributions.

By: Silvia Merler Topic: Global Economics & Governance Date: December 18, 2017
Read article More by this author

Podcast

Podcast

Inclusive Europe: a journey towards integration

How has immigration become an essential part of the EU? What incentives should be made to encourage EU intra-mobility? Why and how should we proceed to foster refugees' inclusion in the EU? Zsolt Darvas and Manu Bhardwaj of Mastercard Center for Inclusive Growth discuss the future of migration within the EU.

By: The Sound of Economics Topic: European Macroeconomics & Governance, Global Economics & Governance Date: December 14, 2017
Read article More by this author

Opinion

South Korea needs to watch the BOJ rather than the Fed

Due its actual economic structure, South Korea should be more worried about BOJ's extremely lax stance than about monetary policy normalization by the Fed.

By: Alicia García-Herrero Topic: Finance & Financial Regulation, Global Economics & Governance Date: December 14, 2017
Read article More by this author

Blog Post

The DSGE Model Quarrel (Again)

Dynamic Stochastic General Equilibrium models have come under fire since the financial crisis. A recent paper by Christiano, Eichenbaum and Trabandt – who provide a defense for DSGE – has generated yet another wave of reactions in the economic blogosphere. We review the most recent contributions on this topic.

By: Silvia Merler Topic: European Macroeconomics & Governance, Global Economics & Governance Date: December 11, 2017
Read article More on this topic More by this author

Blog Post

Moroccan job market issues, and labour trends in the Middle East and North Africa

Morocco is an interesting case of structural labour market disequilibrium despite respectable growth, and illustrates the issues facing the region’s oil-importer countries

By: Uri Dadush Topic: Global Economics & Governance Date: December 7, 2017
Load more posts