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[Podcast] The role of corporate governance on the quality of financial reporting of commercial banks through the level of information disclosure regarding financial instruments

10 September, 2024

Keywords: financial instruments, information disclosure, corporate governance, IFRS7, financial reporting quality,

The quality of commercial banks financial reports depends on the level of information disclosure regarding financial instruments. In Vietnam, there have been neither accounting standards on financial instruments issued nor empirical research on the disclosure of the relevant information by commercial banks. From this study, the author group of University of Economics Ho Chi Minh City (UEH) focused on measuring the level of financial instrument disclosure of banks in Vietnam compared to those of the international standards in accordance with the financial statements number 7 (IFRS 7) as well as examining the impact of corporate governance on the level of this disclosure.

Financial instruments and information disclosure levels in accordance with financial statements No. 7 (IFRS 7)

A financial instrument is a contract (financial contract) that increases the financial assets of one party and the financial liabilities or equity instruments of another party. In other words, a financial instrument is a contract in which the parties directly agree or are stipulated by the issuer on the method of exchanging cash flows or other financial instruments in the future. The value of a financial instrument depends on the issuer’s payment commitment, the liquidity of the underlying asset as well as other market factors.

Currently, in the world, there are 3 international accounting standards (IAS) on financial instruments as follows: IAS 32 – Financial instruments: Presentation; International Financial Reporting Standard (IFRS) No. 7 – Financial Instruments: Illustration; New standard IFRS 9 – Financial instruments. In this research article, the author group uses International Financial Reporting Standards (IFRS) No. 7 to measure the level of financial instrument disclosure by the banks in Vietnam compared to those of the international standards and to consider the influence of corporate governance on the level of information disclosure.

IFRS 7 – Disclosure of financial instruments requires full disclosure of information regarding financial instruments so that users of financial statements can evaluate:

(i) The importance of financial instruments towards the financial situation and business results of the unit;

(ii) The nature and scale of risks arising from financial instruments affecting the entity during the business period and at the reporting date, along with the entity’s risk management method.

In addition, Basel II (Basel Agreement) requires banks to publicly disclose information on capital structure, capital adequacy, bank sensitivity to credit risk, market risk, operational risks and information concerning the bank’s assessment process for each type of risk.

The role of financial instruments at Commercial banks

Commercial banks play an important role in the financial market: banking activities are mainly associated with the creation and use of financial instruments. The bank’s main financial institutions include:

Financial assets from bank credit activities

Credit activities of commercial banks are carried out in different forms as follows: lending, discounting commercial papers, financial leasing, guarantees and factoring and more in addition to creating financial assets, listed as customer lending (including purchasing bonds from the issuer that are not traded on the secondary market).

Financial assets as non-derivative securities

Securities trading is an activity that brings income to banks in the short term from price differences while securities investments help banks enjoy interests from debt instruments or dividends from the issuer from capital instruments.

Equity and financial liabilities

Capital mobilization activities create capital for commercial banks through the issuance of financial instruments listed as capital instruments (for example: stocks), debt instruments (issuing promissory notes, bonds, certificates of deposit), loans from the State Bank or other credit institutions, customer deposits and savings and more.

Derivatives as financial assets or financial liabilities

Commercial banks can issue or invest in basic derivative financial instruments listed as currency derivatives, interest rate derivatives, and credit derivatives whose base objects are exchange rates, interest rates, credit rating and so on. When a bank issues or holds, depending on the changing trend of the underlying object, the derivative financial instruments can be financial liabilities or financial assets of the bank.

In short, financial tools in Commercial banks are very diverse, associated with business activities as well as help to prevent risks for banks. Therefore, financial tools hold an important position in the business results of commercial banks. However, the use of financial tools always implies various potential risks that affect bank stability. Because of the characteristics of financial instruments, accounting policies, measurement and presentation on financial statements require judgment and estimation. The accounting policies on financial instruments depend on the business model of commercial banks. Therefore, the requirements for disclosing financial instruments are more and more demanding in order to provide transparent information to users of financial statements.

Requirements concerning disclose information regarding financial instruments on commercial banks financial statements

Information disclosure is the release of information related to a company, which can affect investors’ investment decisions. Therefore, information disclosure on financial statements has an important impact on the quality of financial statement information, resulting in the effects on users or, in other words, investors – people who make business investment decisions into the unit.

In terms of the financial industry, especially Commercial banks, information disclosure combined with the quality of information disclosure contributes to the information transparency of financial statements. From a management perspective, international banking practices (Basel II) and Central Banks of different countries always set different requirements for information disclosure on financial statements. These measures are to protect consumers and to avoid collapsing risks related to the banking system. From a micro perspective, information disclosure is very important because it helps banks easily access financial sources in the market, reduce capital mobilization costs, resulting in the expansion of market share and the increase in their ability to mobilize capital competitiveness. For that reason, the quality of information disclosure of the Vietnamese banking system has been being low compared to that of other countries in the world, especially compared to some countries that apply International accounting standards (IAS) and International financial reporting standards (IFRS). The State Bank of Vietnam has also issued the documents guiding the presentation of financial statements for credit institutions, including commercial banks, for example: Decision 16/2007/QD-NHNN promulgating the Financial Reporting Regime for credit institutions, Circular 210/2009/TT-BTC on guidance on application of International Accounting Standards on presentation of financial statements and disclosure of information for financial instruments and more; nevertheless, these regulations only have the nature of being the guidelines that imply many limitations compared to that of some countries applying international accounting standards.

In addition, corporate governance mechanisms receive great attention in accounting research and are considered the main driving force for applying IFRS. The Proxy theory suggests that corporate governance structure has a relationship with financial reporting practices, especially the level of information disclosure. This structure is demonstrated through board size, independent members, time length on the board, dual roles, ownership and audit committee.

Actual results of financial instruments announced by Vietnamese banks

The results of measuring the level of financial disclosure practice in accordance with the regulations of Vietnamese Commercial banks in the 2010-2022 period are as follows: The average level of disclosure reached 46%, in which the observation with the highest disclosure reached 82% while the lowest as 6%. Two major contents that need to be disclosed are the importance of financial statements and the risks associated with financial statements with different levels of disclosure. In particular, regarding the importance of financial statements, the level of disclosure is over 52%; regarding risk and risk prevention, the level of practice is lower, at 44%. The disclosure on the importance of financial statements to business results reached 83% – the highest level of disclosure. The lowest disclosed content is risk prevention, averagely reaching 7% of the required disclosure.

In the 2010-2022 period, the average asset size of Vietnam’s commercial banking system increased by an average of 15% per year. The practice level of disclosing financial information as required is an average comprising 64 items of information, the highest unit publishing 96 items of information, the lowest as 8 items of information. The average size of the Board of Directors is 8 members, the highest is 15 members, the lowest is 4 members. Among them, the highest number of independent members is 3. An observation unit states that no member of the board of directors is an independent member. These banks are owned by foreign shareholders while others are not. The highest foreign ownership is 30%. Regarding dual roles, 16% of the observed units have a General Director who is also Chairman of the Board of Directors whereas the remaining 86% ensure independence between these two roles. On average, there are 4 members in the audit committee, with the highest being 7 members and the lowest being 2 members.

Research implications of financial instruments regarding the level of information disclosure towards banks in Vietnam The Vietnamese accounting system has not developed accounting standards on financial instruments yet whereas the research on measuring the harmony between Vietnamese regulations and IFRS 7 contributes to not only the theory of international harmonization of regulations but also the promotion of the development of these standards. Furthermore, the study adds evidence on the explanatory role of corporate governance factors in the context in which some countries have not established standards on financial instrument disclosure yet.

In addition, the research results provide suggestions for regulators and bank administrators in the field of financial instrument disclosure. First of all, to contribute to enhancing the usefulness of information published by banks, Vietnam needs to urgently develop relevant accounting standards. In terms of commercial banks, more attention, in addition to needing to build a strong corporate governance mechanism, should be paid to having more experts in this structure field regarding the board of directors and audit committee to strengthen supervision for better financial report preparation.

In order for banks in Vietnam to provide more useful information, it is, first of all, necessary to promulgate standards on financial instruments. In addition, banks need to have experts in this field in the structure of the board of directors and audit committee to enhance better supervision of preparing financial statements.

Please refer to the full research titled The role of corporate governance regarding the quality of financial reports of commercial banks being measured through the level of information disclosure on financial instruments in accordance with the international accounting standards HERE.

Author: Dr. Nguyen Thi Thu Hien – University of Economics Ho Chi Minh City (UEH).

This is an article in a series of articles spreading research and applied knowledge from UEH with the message “Research Contribution For All – Research For The Community”, UEH respectfully invites dear readers to look forward to upcoming newsletter UEH Research Insights.

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Voice: Ngoc Quy