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«Abstract The paper – that is a part of a bigger project - is based on the assumption of an important relationship between risk management ...»

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Comparative Analysis of Risk Management

and Risk Disclosure in the Banking Sector

Italian vs. World Practices

S. Puccia, M. Tutinob*, E. Marullic

Roma Tre University, Department of Management and Law, Roma, Italy


s.pucci@uniroma3.it - bmtutino@uniroma3.it - cemarulli@uniroma3.it


The paper – that is a part of a bigger project - is based on the assumption of an important

relationship between risk management principles and procedures, corporate governance and

accounting. Its aim is to evaluate what are, at this stage, the theoretical approaches and the practical solutions adopted by the companies to manage the risks and to disclosure to stakeholders qualitative and quantitative elements referring to this aspect and necessary to evaluate the company profile. The paper examines the 2010 Consolidated Annual Reports of a sample of 25 Italian and worldwide listed banks on two main topics: (i) the quality of disclosure on Internal Organization Process Risk in terms of correspondence to the international best practice framework as stated in CoSo reports, (ii) the instruments adopted in the Risk Management Process to assess corporate exposure to market risk, focusing on Interest Rate risk, Price risk and Currency risk 1.

Keywords: IFRS 7, Risk Disclosure, Risk Management, ERM, Banks Introduction Since 2005, over 7,000 listed firms in the European Union and many more around the world are required to adopt International Financial Reporting Standards (IFRS). The introduction of a uniform accounting regime is expected to ensure greater comparability and transparency of financial reporting around the world. However, recent research has questioned the quality of financial statements prepared under IFRS standards, particularly in the presence of weak enforcement mechanisms and adverse reporting incentives (Ball et al., 2003).

In this context, the relation between risk management, corporate governance and accounting risk disclosure has significantly grown, especially in the banking system (Bhimani, 2009; Power, 2009; Harney, 2010). This importance was recently highlighted by the financial crisis in 2008 that has shown the “weakness” of some corporate governance and risk management principles and of some accounting standards (OECD, 2009).

The relationship between accounting, corporate governance and risk management principles is the subject of this paper. In particular, the paper examines the level of compliance of risk management disclosure policies - so that, risk exposure, risk evaluation and risks hedging S. Pucci (par. 3, 6); M. Tutino (par. 2, 4.1, 4.2, 4.3.), E. Marulli (par. 1),all authors: par. 5 policies – adopted by a sample of listed companies to IFRS 7 issued in 2007 in order to assess if accounting principles requirements are considered and transparently reflected in the Notes of Annual Report and related disclosure (i.e., risk reports). In particular, the research is focused on disclosure for market risks exposure and risk management process in terms of objectives, policies and internal organization.

After a brief review of the literature and a short discussion of the theoretical approach, the study analyzes the banking sector data, comparing a sample of Italian listed banks with a sample of the largest world banks. The analysis follows two-step logic. The first step includes a selection of more representative Italian listed banks and provides analysis on the following aspects: (i) details on internal organizational structure in order to manage market risk exposure, as defined by each bank in its annual accounts; (ii) information about policies and tools adopted to assess and manage market risk exposure, considering compliance with specific requirements stated in IAS/IFRS principles. In the second step additional banks considered representative of the best practices in organizational processes and tools used in market risk and compliance to disclosure requirements were selected from among the world’s twenty-five largest banks.

Nationality was varied as much as possible. The analysis has been extended to answer to

following research questions:

- Are accounting and non-accounting standards requirements (IAS/IFRS, SFAS, CoSo Report discussed and other accounting practices) sufficiently standardized and homogeneous in the banking sector to permit a good level of knowledge of structures, objectives and policies adapted to manage risk?

- Can the risk management process - in terms of functions of the internal organization involved, specific instruments adopted and parameters used in calculating risk exposure and evaluation - be considered "globalized"?

- How much do both previous items impact management and policies adopted by banks referring to market risk?

Literature Review

Many academic contributions have recently focused on the relation between risk management, finance, corporate governance and accounting and on their techniques. In particular, some papers have analyzed, from a theoretical point of view, the relation between accounting and finance (Pope, 2010) and accounting and risk management (Bhimani, 2009, Power, 2009; Harney, 2010); some authors have estimated, from a quantitative point of view, the relation between accounting and the measurement of risks (Carey, 1995; Anderson and Fraser, 2000; Agusman, Monroe, Gasbarro, and Zumwalt, 2008; Behr, Schmidt and Xie, 2010); while others have examined the link between incentives for risk reporting and discretionary disclosure (Dobler, 2008). Risk management is also connected to the theme of sustainability (Krysiac, 2009). In recent years, the relationship between risk management, corporate governance and accounting has also been analyzed by local and international supervisory authorities, by international bodies and by groups of experts who try to find the “best” framework in which to define risk management objectives and policies and their reporting in internal documents and in financial statements. Important points of reference are the OECD Principles of Corporate Governance (2004), Enterprise Risk Management Principles defined by CoSo (2004) and subsequent guides such as Developing Key Risk Indicators to Strengthen Risk Management (2010), the AIRMIC papers (2008, 2010) and some IASB and FASB accounting principles in which information about risk evaluation and solutions are required.

Risk management Function, Policies and Disclosure Rules

As AIRMIC affirms in its 2010 Report “the risk architecture needs to be clearly defined, regardless of the risk maturity or expectations that the company has for risk management. The nature of the risk architecture should be relevant to the risk profile of the company” (AIRMIC, 2010, p. 2). As it has been previously underlined, the companies have a lot of theoretical and empirical solutions to define the risk architecture and the choice applied has a great influence on the way in which the risk is assessed, managed and reported. This is an internal choice of the company that is related to the size, the internal organization model, the market in which the company acts and the environment (laws, accounting standards, products, clients, competitors, etc.).

The disclosure of risk management exposures, strategies, policies and the effects that the choices made produce on the “profile” of the company impacts all stakeholders and may have an important role in the company evaluation by market investors. Because of this, both IASB, FASB and other standard setters and supervisory authorities have shown a great interest in disclosure requirements regarding risk management. The requirements are often qualitative and quantitative and, combining both information perspectives, it would be possible to have a clear knowledge of the risk management approach followed by the companies (Managerial Risk) and of the effects on the present and future cash flows (Organizational Risk). As an example of the qualitative information required, par. 33 of IFRS 7 states that “for each type of risk arising from

financial instruments, an entity shall disclose:

(a) The exposure to risks and how they arise;

(b) Its objectives, policies and processes for managing the risks and the methods used to measure the risk; and (c) Any changes in (a) or (b) from the previous period”.

Research Methodology and Data

For the purposes of the research, a sample of banks adopting different accounting principles has been observed. The next paragraphs provide the frameworks used to deal with research questions previously stated, the methodology adopted in the analysis, the sample observed, and main data recorded and organised in tables.

In order to underline differences in practices adopted, cross-sectional analysis has been conducted for a comparison. Companies’ Risk Reports, included in their Annual Reports, have been analysed. The analysis has been focused on 2010 Consolidated Annual Reports and 2011 Quarterly Reports of a wide sample of Italian and World listed banks. Sections below provide focus and objectives of research, with evidence of main research questions, methodology adopted and the sample of research.

Focus of research The main objective of the paper is to measure the degree and the completeness of risk disclosure using IFRS 7 as a proxy for best practices. We provide analysis of the information released in Annual Reports distinguishing risk management approaches adopted by a single bank, the deepness of disclosure provided on risk management processes, and the size and position of risk disclosure in the annual reports in order to evaluate the degree of transparency of the disclosure provided by the full sample. That being stated, the topics of analysis paper can be

summarized as follows:

- The quality of disclosure on internal organization process risk in terms of correspondence to the international best practice framework as stated in the CoSo report,

- The instruments adopted in the risk management process as stated in IFRS 7 in order to control for corporate exposure to market risk, focusing on interest rate risk, price risk and currency risk,

- The impact of previous items on management and policies adopted by banks referring to market risk.

The Committee of Sponsoring Organizations of the Treadway Commission's (CoSo) “Enterprise Risk Management (ERM) –Integrated Framework” is a model for reviewing and assessing the quality of internal control systems and risk management processes. According to

CoSo, the ERM framework facilitates three main classes of objectives:

- Operations objectives: efficient and effective operations;

- Financial reporting objectives: reliable financial and non-financial reporting; and

- Compliance objectives: compliance with internal procedures and external laws and regulations.

The following figure (Figure 1) summarizes the CoSo framework.

–  –  –

CoSo (2011), Draft Update to Internal Control - Integrated Framework, available on http://www.coso.org/documents IFRS asks for disclosure of a wide range of “risks arising from financial instruments”.

The following figure (Figure 2) shows the risk disclosure framework as stated in IFRS 7

referring to market risk:

–  –  –

Redaelli L. (2007), La prima applicazione del principio contabile IFRS 7, PWC Conference Proceedings, Milano, 29 November.

Main research questions

The main research questions, as stated in paragraph 1, are the following:

- Are accounting and non-accounting standards requirements (IAS/IFRS, SFAS, CoSo Report discussed and other accounting practices) sufficiently standardized and homogeneous in the banking sector to permit a good level of knowledge of structures, objectives and policies adopted to manage risk?

- Can the risk management process - in terms of functions of the internal organization involved, specific instruments adopted and parameters used in calculating risk exposure and evaluation - be considered "globalized"?

- How much do both previous items impact management and policies adopted by banks referring to market risk?

Methodology and sample A content analysis methodology has been adopted in this research. This is a transparent and flexible method that can also be used for both qualitative and quantitative studies and allows comparative analysis between samples. In particular, this paper analyzes the content of consolidated annual financial reports adopting a replication logic (Eisenhardt, 1989), which allows each “analytic unit” observed to be considered as a “new experiment” useful to extend emerging theory (Yin, 1984).

We have used data from 2010 Consolidated Annual Reports and 2011 Quarterly Reports from a sample of 25 listed banks. We selected banks from the Italian market (17) and foreign markets (8) to compare disclosure. The sample banks were selected taking into account two main parameters.

First, the substantial absence of relevant control between companies in terms of level of autonomy in the governance process. Even if some banks included in the sample are linked with crossing participation in share capital, each bank can be considered as a single market player relative to the others.

Second, we selected a sample of banks with a wide range of financial services. All but two were involved primarily in the core business of financial intermediation, such as lending activity to public and private sectors. Two banks (Mediobanca and Banca Finnat) were included because of their growing presence in the specific operating area and their “political weight” in the Italian banking sector. Nevertheless, most of the Total Assets of banks included in the sample is invested in lending activity. For the World sample we chose 8 top listed banks included in the FT Global 500 list, released in March 2011, considering 8 different countries.

The following table provides the whole sample investigated, ranked by Total Assets as of 31 March 2011, as stated in FT Global 500. Because of size, some Italian banks were not included in the list mentioned. The value of total assets expressed in dollars has been calculated using the Euro/US Dollar exchange rate at a specific date multiplied by the value released in reports by each company. The sample observed is reported in the following table (Table 1).

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