Supervisory guidance for assessing banks’ financial instrument fair value practices

Over the past year, risk management and reporting issues related to bank valuations of complex or illiquid financial instruments, and the implications for regulatory capital requirements and bank supervision, have received considerable attention. The application of fair value accounting to a wider range of financial instruments, together with experiences from the recent market turmoil, have emphasised the critical importance of robust risk management and control processes around the measurement of fair values and their reliability. Moreover, given the significance of fair value measurements for regulatory capital adequacy and internal bank risk management it is equally important that supervisors assess the soundness of banks’ valuation practices through the Pillar 2 supervisory review process under the Basel II Framework.