Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Daily Archives: April 13, 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
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

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
describing the implications of IFRS for Indian insurance

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

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.