when business stands still when business stands still

Magazine of The Institute of Chartered Accountants of Pakistan

ACCOUNTANTOCT-DEC

2009

ACCOUNTANTTHE PAKISTAN

WHENBUSINESSSTANDS STILL

WHENBUSINESSSTANDS STILL

GLOBAL CREDIT CRISISComplete Chronology ofSPECIAL REPORT

EDITOR'S LETTER 2

PRESIDENT'S PAGE 3

JOIN THE DISCOURSE 5

COVER STORYWhen Business Stands Still

Aamir Jan Muhammad, FCA 9

Financial Leadership in an Age of

Turbulence

Khursheed Kotwal, FCA 12

No Strategy Without Operations

Rana Mustansir 15

ARTICLESA Critical Analysis of Accounting Practices

Prevailing in the Mutual Funds in Pakistan

Muhammad Rashid Zafer, ACA 17

Reporting on the Long-Term Sustainability

of Public Finances

Ian Sanderson, FCA (E&W) 22

Auditor’s Report in Pakistan

Muhammad Asif Iqbal, FCA 24

Complexities and Absence of Uniform

Valuation Process of Intellectual

Assets Valuation

Mohammad Hanif Ajari, FCMA 30

Advanced Fee Fraud

Saima Batool & Wasi Ahmed 34

Audit File

Sadia Kaleem, ACA 35

Living in a Bubble 37

The Credit Crisis at Your Fingertips

IN HOUSECase Vignette 55

World in Focus 57

Books 59

Last Page 60

Volume 43 Issue 4 October-December 2009

Publications Committee

Chairman and Chief EditorAdnan Zaman

MembersAbdul RashidAbdul WahidAdnan Ahmad MuftiAijaz AhmedAltaf Noor AliAsad FerozeHeena Irfan AhmedJehan Zeb AminM. Amir Afzal RanaM. Fahim A. RaufMuhammad Rehan RazzakMutee-ur-Rehman MirzaOmar Mustafa AnsariRaheel Abbas Rizvi

Advisor Publications

Rana Mustansir

The Council

PresidentAbdul Rahim Suriya, FCA

Vice PresidentsMohammad Abdullah Yusuf, FCAPervez Muslim, FCA

MembersAdnan Zaman, FCAAhmad Saeed, FCACh. Nazir Ahmad Asad, FCAHafiz Mohammad Yousaf, FCAKhalid Rahman, FCAMuhammad Ayub Khan TarinNadeem Yousuf Adil, FCANaeem Akhtar Sheikh, FCARafaqat Ullah Babar, FCARashid Rahman Mir, FCASalman Ali ShaikhShaikh Saqib Masood, FCASohail AhmadWaqar Masood KhanYacoob Suttar, FCAZahid Iqbal Bhatti, FCA

Executive DirectorMoiz Ahmad, FCA

SecretaryShoaib Ahmed, ACA

Publication CoordinatorAsad Shahzad

Editorial OfficeThe Pakistan AccountantChartered Accountants Avenue, Clifton,Karachi-75600 (Pakistan)Phone: 99251636-39 Fax: 99251626E-mail: [email protected]: www.icap.org.pk

WHEN BUSINESSSTANDS STILL

PAGE#9 PAGE#17

PAGE#PAGE#22Reporting on theLong-TermSustainability ofPublic Finances

Living in a BubbleThe Credit Crisis atYour Fingertips

37

A CRITICAL ANALYSIS OF

ACCOUNTING PRACTICESPREVAILING IN THE MUTUALFUNDS IN PAKISTAN

The Pakistan Accountant Oct-Dec 2009 1

C O N T E N T S

SPECIALREPORT

A few years ago the US based *Financial Executives Research Foundation dida study on what operational people thought about their financial counterparts.More than 50% respondents described their finance managers as ‘corporatepolice’. If the Chief Financial Officer is perceived as a prosecutor would hismanagers come to him for help?

One of the tenets of the Sarbanes Oxley Act is that boards should have an activerole in strategy. Incidentally, most board members come with operationalbackgrounds. Thus, the CFO needs to bring his strategy to the board in a waythat allows the board to align themselves with his strategy.

Traditionally, accountants’ role in strategic planning has beenconfined to the implementation phases where strategies areconverted into budgets. May be that’s because strategicplanning requires managers to throw the rule book out thewindow; something accountants are not programmed to do.

Times are changing, though. Professional accountants arestanding up and being counted for as strategic decision makers.Strategic planning defines a business’s mission, evaluates itsstrengths and weaknesses, identifies opportunities and threats,and realigns resources to achieve the goals of the business. This

is where all those advanced quantitative techniques and NPV calculations startto make sense. Add to that an understanding of the profit implications ofgoodwill, brand recognition and other intangible assets, and you have anaccountant who can greatly benefit the planning process.

But if finance managers really want to be seen as strategic business thinkersthey must shift their traditional emphasis on compliance to a long termperspective to analyze the performance of their enterprise. They must seek tolearn from their operational business partners who possess process knowledge.Whether in manufacturing or in services accountants must participate fully inestablishing processes. They must learn to embrace organizational diversity andbe willing to take creative risk.

Most important, they must realize that at its core any enterprise is a collection ofpeople and, therefore, business strategy must define the collective intelligenceand aspirations of all those people. The relationship between people, processand product must be sustained at all costs.

The game of bridge is often referred to as the game of strategy. It’s part science,part math, part logic. Like business. But bridge is also very human, where instinctmatters more than reason. Just as business strategy should be; where businessacumen doesn’t override human potential. It develops it.

Adnan Zaman

Editor’s LetterWHEN BUSINESS STANDS STILL


E D I T O R Ê S L E T T E R

* The Financial Executives Research Foundation (FERF) was established in 1944 to perform impartialand independent research on financial management and reporting.

WHEN BUSINESS STANDS STILL

President’s PageDuring my years with the pharmaceutical industry, the term Big Pharma soundedvery intimidating. Big Pharma defines the concentration of the largepharmaceutical companies. In contrast to small and medium sized localcompanies, these companies coordinate and manage a complex network ofalliances and partnerships between them.

Whatever the structure of the pharmaceutical industry in Pakistan, it seems thatBig Pharma will have a significant role in determining business practices. Thepharmaceutical industry has been one of the most profitable industries for manyyears and is considered a recession proof industry. Local pharmaceuticals could

generate considerable revenue from exports over time if thegovernment provides a business friendly atmosphere to thissector.

Another area where local pharmaceutical companies cancompete internationally is outsourcing. China is now beingranked as the number one location for pharmaceuticaloutsourcing in Asia followed by India, Korea and Taiwan. Thesecountries are emerging not only as low-cost production locationsbut also as locations with market potential and research anddevelopment capacity.

The government needs to devise a strategy for the local pharmaceutical industryto compete and make the most of the opportunities available to Asian countries.This is a critical growth opportunity that this industry can not afford to miss.

Some companies continually face tremendous challenge in creating profitablegrowth. Then there are other companies that achieve sustained growth in bothrevenues and profits. Numerous business studies of high growthcompanies over the years have shown that the difference between high growthand low growth lays in the way these companies approach strategy.

Less successful companies take the beaten path: the conventional model ofalways staying ahead of the competition. Successful companies on the otherhand take the road less traveled: they innovate. They don’t compare themselvesto rival companies; they don’t try to match or beat competitors. They don’t allowcompetitors to set parameters for their success. They use their competitors’strengths not to identify their own weaknesses, but to build on comparativeadvantages.

They believe in their core strengths and add value to them. They put asideconventional thinking and deliver a package that their customers would highlyvalue. Successful companies monitor their competitors, but they do not do thingsin response to what the competition is doing. They do not scramble forincremental share. They aspire to create their unique value in whatever they aredoing.

Abdul Rahim Suriya


P R E S I D E N T Ê S P A G E

JOIN THEDISCOURSE

This issue’s topic is:Does IT Matter?*“The differentiation is not in IT itself which iseverywhere and increasingly less expensive thesedays, but in the new practices it enables.”Brown & Hagel

As technology diffuses in to every aspect oforganizational life, IT is fast becoming a commodity.With more companies investing heavily in IT andwith more and more IT products being standardizedand their cost falling, should Information Technologybe viewed merely as a commodity or as an enablerof new business practices?

C O M M E N T S

J O I N T H E D I S C O U R S E

It does matter on who is sitting behind the wheel. No doubt,living in this vibrant era without IT is even hard to imagine butmaking this tool to be used as a best business practicesenabler is an art, which practically very few organizations havelearnt so far. However, at least through IT’s widespreadavailability at affordable price this is now not an elitecommodity for a few entrepreneurs. Its best businesspractices features can be utilized by any entrepreneur at hisdiscretion.

Amer JanGM Finance (South) PTCLKarachi

IT is no longer a black box. IT is an integral part of the enterprisefunctionalities and a board needs to understand the overallarchitecture of its company’s IT applications portfolio. Havingworked for an Institute for Corporate Governance for nearly threeyears now, this brings me to highlight the importance of ITGovernance, the lack of which has led to various IT project failures.

Lack of interest at the Board level in IT related decisions led tothe failures resulting in substantial financial loss such as DisneyCorporation’s “go.com” project shut down after $878 million inexpenditure, Nike’s $400 million investment in software whichwas subsequently written off as a disaster and the AustralianCustoms Imports Control System when customs insisted ongoing live with its own systems, the industry was not ready andthe ports effectively closed down for three weeks until the oldsystems were brought back into action.

Hence IT does matter.

Jahanara Sajjad AhmadUnited Arab Emirates

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IT is definitely not a commodity as commodity is somethingwhich is supplied/provided without qualitative differentiation. ITon the other hand can make or break an organization as it hasbecome such an integral part of corporate framework.

Khwaja Kamran ShahConsolidation Manager Group Corporate FinanceDubai

Yes, IT matters a lot. Specifically speaking about the bankingindustry, technology has the biggest and most critical role notonly in innovative product development but also in providingswift customer services. IT has completely changed the thoughtprocess of the bankers where every product, process andactivity is conceived keeping in view its technological elementsand the amount of support it provides from conception toproduction.

From the simplest of the consumer banking products to the mostsophisticated structured products and from archival to auditprocess, IT has revolutionized everything. Though few would stillargue that IT is a luxury and the cost associated is still relativelyhigh. However, in the longer run and in a broader perspective IThas reduced cost considerably with automation of processes.

All in all, IT is an integral element of modern day business and itcannot flourish without IT.

Syed Raheel HashmiHead - Quality Assurance | Operational Risk ManagementNoor Islamic Bank

I support the point of view that IT enables business practices.The most relevant example of this is the system of transactionsand payments through credit cards. The use of credit cardsincreases purchasing power resulting in overall increase inbusiness activities, and this system of credit cards was notpossible without the help of IT.

Jamil AhmedLahore

Information Technology is already viewed as an enabler ofbusiness practices in meeting strategic requirements andsustaining competitive advantage. In current e-business world,information technology is the catalyst for creating entirely newbusiness models. It is not only part of the fabric of theorganization, causing companies to restructure businessmodels, but IT has also changed the way they manage customerrelationships, work with their business partners, and formstrategic alliances with competitors. In this new economy,companies must leverage the enormous opportunitiescontinually created by technological advances to meetthe strong demands of complex information networks, anincreasingly dynamic global economy, and a ‘never-satisfied’customer.

Qaiser Vakani Group Consolidation Manager SThree Management Services

I’ve always considered IT as an enabler of new businesspractices. Having served in the financial services industry since2001, I’m confident that the growth of this industry over the pastseveral years has been achieved because of new IT practicesacross the business either through online account activity,mobile banking, credit or debit card. Going forward, we will seefurther differentiation in financial products based on IT’sinnovations. Soon you will find people managing entirebusinesses sitting at home, thanks to IT once again. At ABL

AMC we believe in the same strategy and think out of the boxto design new products based on the latest technology available.

Faisal Nadeem MangroriaHead of Internal Audit & Compliance ABL Asset Management Company LimitedKarachi

The collapse of geographic boundaries has made the world aglobal village, thus business must acknowledge the need forInformation Technology. IT has challenged the more orthodoxways of business practices. It revolves around the automatedprocesses that require little or no human intervention. This inturn has eliminated repetition of tasks, risks involved due tonegligence of timely upgrades and extensive paper-intensivebusiness applications that result in the accumulation ofunnecessary bulk. Thus IT cannot be viewed as a merecommodity.

In a nutshell, IT has caught on in the form of a communicationrevolution for modern day business and revolutionized more orless all business sectors around the globe, thereby changing oldbusiness practices.

Zaryab HyderManager | Assurance Ernst & Young Ford Rhodes Sidat Hyder Karachi

In my opinion how IT is viewed depends a lot on the way it isbeing implemented by an organization.

Even when an organization merely involves IT for automation ofits operation without any business process re-engineering, it isrequired to mould some of its processes accordingly.

But if IT is implemented in its true spirit it forces organizations todevice a number of new business processes, adopt bestpractices and re-engineer their existing processes. Only in thatway can IT act as enabler and not as a commodity.

Ayesha AshfaqAssistant Manager Corporate FinanceMinistry of Petroleum and Natural Resources Islamabad

IT does matter but it’s being over-emphasized in current times.So much so that we are more concerned about the left and rightmargins of a report and less concerned about the message thatmatters more.

Saleem AhmedSenior Manager | Audit & AssuranceM. Yousuf Adil Saleem & Co. Chartered Accountants

IT is bringing wide ranging and significant changes to businesspractices. Not only are the traditional operational methods ofprocurement, manufacturing, distribution and sales beingmodified to bring in effective and efficient techniques into play,but the back end support systems in an organization includingfinance, human resource and administration are also evolving tothe changing business processes. Be it a market segmentationstudy or an efficient production process, a balance sheetforecast or employee performance appraisal, IT continues toenable new dynamic practices to the operating businessenvironment.

Sibtain Shabbir HussainManager Treasury | Lakson Tobacco Company LimitedKarachi



Certainly, the topic is interesting. How could IT be considered asa mere commodity, when businesses all around the globe areGLOBAL today, thanks to the rapid development of IT services.Therefore, IT is a tool for business development and enabler inthe true sense of the word.

Abdul Sattar TabbaniKarachi

The principal role that information technology has performed inthe past has been the operational and management support. Butrecently the use of information systems as competitive weaponsis accelerating. Among the classic cases of strategic informationsystems are the computerized reservation systems of airlines,the cash management system of financial institutions, and theorder entry system of the supply chain sector. The companieshave now begun using information systems practicesstrategically to reap significant competitive advantage.

Muhammad Arshad HasanChief Financial Officer Lahore School of Economics Lahore

Does IT Matter? implies that IT has dramatically changed therole of business, its leveling effect on competition, and thepractical implications for business managers and IT suppliers.The vital role of ERP, other IT solutions and hardwarecombination also enables businesses to introduce newconcepts, new processes, new products and even capture newmarkets. I believe that a company has to employ IT consideringits present and future needs to the extent that they make itsoperations efficient, deliver a better customer experience andgain a competitive advantage.

Haroon Sulaman Manager Audit & Systems Sitara Textile Industries Limited Faisalabad

“The differentiation is not in IT itself which is everywhere andincreasingly less expensive these days, but in the new practicesit enables.”

This is completely true. IT has permeated all walks of our lives.It has not only changed the way we do business but also the waywe operate in society and interact with each other. The advanceof social networking and Web 2.0 has completely transformedthe concept of human interaction though at the cost of personalprivacy.

IT has allowed businesses to break new frontiers in all respectsfrom materials management to marketing. It has madeorganizations more nimble, flexible, customer focused andhighly efficient. It has also questioned whether the profession ofaccountancy is there for the long haul given the advancementsin IT, though this would perhaps be something to be debatedseparately.

M A ShaikhLondon

IT has indeed changed the way everything used to be done.What needs our attention though is that we don’t get carriedaway with the IT drive by adopting IT for the sake of IT. Each steptowards automation and IT should be well calculated with clearobjectives, modalities and risks in mind. While IT addressesmany issues, it brings with it new risks in the areas of systemsintegration, data migration, disaster management, information

security and most importantly, the need for a sense of how ITleverages the overall organizational strategy.

Syed Shahid Abbas RizviMobilinkIslamabad

Nobody can doubt the horizons that IT has opened businessesto. IT usually does not of itself materialize as a product ofmodern business but it surely leads to differentiation through acompetitive edge over rivals. In the last three to four decades IThas transformed from mere data processing to BusinessIntelligence.

There are many examples of business failure where IT isinvolved, but fact finding exercises reveal that what was missingwas management. It would not be wise to spend millions ofrupees to keep abreast of the latest technology. What matters isthe alignment of IT Strategy within the Corporate Strategy.

On the other hand IT as a product has put companies like IBMand Microsoft in Fortune 500’s top 50 rankings. In the earlynineties, who knew that web based companies like Google,Yahoo etc. would become the big guns of the corporate world.

Imran-ul-HaqLahore

IT has changed the way companies carry out many importantactivities, but it has also led managers to invest cash into riskyand misguided initiatives. As IT has become more standardizedand more affordable, it has been transformed from a proprietarytechnology that companies can use to gain an edge over theirrivals into an infrastructural technology that is shared by allcompetitors.

Owais MukatiKarachi

A N A L Y S I S

In the year 2000, nearly half of US corporate spending was onInformation Technology. Companies were making hugeinvestments, particularly in e-business initiatives, in an attemptto achieve competitive and strategic advantages. However,these projects never produced significant benefits. Indeed, manywere never completed. Then there was a significant fall inspending on technology. NASDAQ collapsed and eyebrowswere raised and questions were asked whether IT was dead orwhether it would continue to be a source of dramatic, eventransformational change.

In this backdrop Nicholas G.Carr’s essay “IT Doesn’t Matter”appeared in the May 2003 issue of the Harvard Business Reviewclaiming that “ technology’s potential for differentiating onecompany from the pack – its strategic potential – inexorablydiminishes as it becomes accessible and affordable to all.”

The thrust of Carr’s argument was:

� IT has ceased to be a scarce good and can now be acquiredfrom the marketplace like any other commodity.

� Businesses had overestimated the strategic value of IT andin their desire for acquiring business value had significantlyoverspent on technology.



� Whole industries rather than any one competitor wouldbenefit from these changes.

Based on the above analysis Carr concluded that IT has lost itsstrategic value and that businesses instead of seekingadvantage through technology should manage their ITinfrastructures in a way that would reduce capital investment andoperating costs and that they should ensure the reliability andsecurity of their systems by employing effective riskmanagement techniques.

Not surprisingly, “IT Doesn’t Matter” generated an enormousamount of debate. It drew criticism from Bill Gates and others inthe IT industry that had prospered and flourished by marketingthe strategic value of technology.

Those who disagree with Carr argue that:

� IT does not matter in isolation. It only matters in the contextof a concerted effort to innovate based on new possibilitiesand opportunities created by the technology:

IT networks and the Internet have made it possible forcompanies to extend their operations globally. Newentrants have joined many industries and have focusedon taking strategic advantage of the economicsassociated with IT.

IT has enabled industry’s transaction costs to decreasecontinually, making it possible for the firms to makeproducts and services that were not feasible in the past.

The Internet has made the explosive growth of smallbusinesses possible.

The management of information intelligence and collaboration among individuals, groups, andorganizations has improved dramatically.

� Unlike commodities like rice and steel, where the processingoperations are well understood and the economic advantagelies in being able to source the commodity at lower cost,managerial capabilities are needed to create value withtechnology.

� On its own IT may not confer strategic differentiation, but itcertainly creates opportunities that were not previouslyeconomically available. Companies that see and act onthese possibilities before others do will continue todifferentiate themselves in the marketplace and reapeconomic rewards. However, the insight required to harnessthis potential will never be evenly distributed. Therein laysthe opportunity for significant strategic advantage.

� To extract value from IT companies need to makeinnovations in business practices: improving cost savingsand efficiencies, making better organizational structures,products and services, creating strategic advantage throughpartnerships, and providing new IT-based services to extendthe customer value propositions.

� IT developments have not reached the saturation point andwe would see more and better innovations.

� The need to pay more attention to IT risks is undisputable,but the risks do not exceed the advantages.

The quantum leap promised by those marketing strategic use oftechnology may not have materialized, however, InformationTechnology has made it possible for businesses to improve their

processes, and has positively affected organizations at thestrategic, tactical and operational service delivery levels. Therewards from this transformation have not been evenlydistributed; those who had the insight and ability to createeconomic value have benefited the most.

Furthermore, IT developments have not reached a plateau. Wewill continue to see better and more innovative softwareproducts. However, to gain a significant strategic advantagecompanies will also have to make innovations in businessespractices.

Ahmad Saeed KirmaniKarachi

Members are requested to send in their comments with theirname, town and membership number, via email in care of

[email protected] with the word DISCOURSE

in the subject heading.

Responses will be edited for purpose of clarity and space.

* The two Harvard Business Review articles that became the basis forthis DISCOURSE are:

IT Doesn’t Matter by Nicholas Carr, Editor-at-Large for the HarvardBusiness Review, HBR, May 2003; and

A response to Carr’s article, titled Does IT Matter?, by John SeelyBrown former Chief Scientist at Xerox, and Management Consultantand author John Hagel, in the Letters to the Editor section of HarvardBusiness Review, HBR, July 2003.


Dear Members

Thank you very much for taking time out to answer ourDISCOURSE question.

The number of responses this question has generated provesthe significance of Information Systems in providing acompetitive advantage.

The crux of this debate is that IT by itself may not provide abusiness with a strategic advantage, but IT createspossibilities that can only be fully exploited when thebusiness is ready to change its practices. Technology willmake a business or a service more efficient only when theright people are continually working to improve the rightprocesses.

Once again you have helped us maintain the vibrancy anddecorum of this open discussion forum.

Please continue participating.

Publications Department, ICAP


In comparison to external factors, internal factors

are leading indicators and have more influence on

business collapse in general.

Aamir Jan Muhammad, FCA

WHENBUSINESSSTANDSSTILL

WHENBUSINESSSTANDSSTILL

C O V E R S T O R Y


External economic and other factors are beyond thecontrol of any entrepreneur and generally he cannothelp it in overcoming those factors, rather only takeinternal measures to mitigate the negative influence of

these factors to limit the risk of loss to the business at tolerablelevel. However, certain businesses lose momentum andconsistency mainly due to complacency by reaching a certainlevel and through experimenting new impulsive ideas based onwhims without chalking out a proper business plan or taking intoaccount calculated risk associated with the implementation ofnew ideas.

In the paragraphs that follow we will outline the major internalfactors which lead to the demise of profitable business entities:

NOT ACCEPT ING COMPET I T I VE CHANGE

Most enterprises, especially those enjoying monopoly in theirproducts, become the victim of egoistic managerial mindsetsand after the emergence of any competition close their eyes to itand gradually lose market share. Contrary to this newcomers actmore aggressively with new customer focused ideas and betterservice providing mindset and gradually capture the marketthrough competitive edge over its monopolistic entrepreneur andin the long run become the true market leader in a competitiveeconomic environment.

Theoretically speaking, it seems obvious that a strong businessenterprise with a thorough market share would be in a betterposition to outclass its new competitor by adopting changedcustomer focused strategies. However, in practice it does nothappen as entrepreneurs who are enjoying guaranteed sale oftheir products at desired margins fail to accept the reality ofcompetition by assuming that conditions will remain the samewhether or not they react in a positive fashion to the changedmarket conditions. This slackness of entrepreneurs leads togradual decline of their businesses and in most of the cases,total collapse.

Prime examples in Pakistan are some big business enterprisesthat either closed down, or lost their market share, or grappledwith huge losses. For instance, one of the largest multinationalelectrical companies operating in Pakistan with a strong brandimage and market share in electrical products closed down itsmanufacturing units and substantially lost its business share tolocal competition. One of the largest multinational companiesdealing in tea lost market share to a local competitor even aftermerger with another big company, and the monopoly of amultinational dealing in cooking oil and related products marketwas also captured by new local businesses. On the internationalfront the recent bankruptcy of renowned automobile companiesare some examples.

The most common factor amongst major big companies losingmarket share or giving free space to the new entrants is mainlydue to the fact that they were unable to retain their customers byoffering them products and services matching changingdemands and consequently failed to satisfy their customers.This rule of constant change applies to all facets of life andobviously to businesses as well. Those entrepreneurs whorealize this factor and constantly work on continuousimprovement to delight customers through their competitiveproducts and services never fall victim to business crisis.

DEC IS ION MAK ING ON IMPULSE

In the long run only those businesses survive which are

managed through defined processes and not by few individuals’whims and impulsive ideas. There is an old saying “if it ain’tbroke don’t fix it”. Businesses sometimes become victim ofundue influence of high management over decision making.Chief executives are sometimes so obsessed with their ownideas that they are not willing to listen to any arguments againstthem or take into account risks associated with the project. Forexample, getting into a totally different line of business with norelation to existing business products and services, businessmergers and demergers, discontinuing old product lines andreplacing them with new products without market survey,introduction of new product to wrong market segment,overspending on established brands, getting into price warswhile compromising the company’s profit margins etc.

ORGA N I Z AT I O N A L S T RU C T U R E

People are the key resource of any organization and the key todestroying any business enterprise is to destabilize theorganization structure of that company. Though this basic factoris not considered that important in many established businessorganizations but this is the key for the long term survival andgrowth of any business entity working in any economy of theworld.

Think for a while a company with a defined organogram of alldepartments with reporting hierarchy, defined cadres, justifiedpay structure at all levels, job descriptions, key performanceindicators (KPIs), assigned SMART targets at all individuallevels, succession plans, performance appraisals, reward and

C O V E R S T O R Y


reprimand mechanism and above all proper communication ofcompany’s objectives to all levels from bottom to top.

Under this organized scenario everybody knows their role andwould be satisfied with their job at the end of the day by realizingthe fact that their performance is being judged and he/she has adefined career path. Contrary to this if these mentioned factorsare missing in the organization, no matter how skilled andtalented people working with that company are, overwhelmedwith work everybody would just be passing the buck around tosafeguard their jobs and at the end of the day companyobjectives would not be achieved.

Another related aspect which has a critical impact on a

company’s business is the brain drain of employees throughimplementation of disorganized Voluntary Separation Schemes(VSS). Downsizing of staff without chalking out future placementneeds in terms of skilled human resource becomes a slowpoison for the business and in the long run seriously affects thecontinuity of the business. In large organizations where VSS areoffered those with skills and job opportunities in the market arethe first to opt for the scheme as it gives dual benefits to them.Consequently, if general VSS is offered then at the end of theprocess the company is left with employees less in demand bothwithin and outside the company. Personally speaking, andbased on the author’s work experience, most of the VSSschemes, though it is difficult to quantify its intangibleconsequences, are not well planned and have resulted in a braindrain of key human resource which subsequently affects thecompany’s performance.

CONCLUS ION

In all facets of life basics play the key role. In the current globaleconomic scenario the rule of “survival of the fittest” applieswhereby entrepreneurs need to keep their business fit for allenvironments by bringing innovation to products and services inline with changing market trends.

For the long term survival of business enterprise in thecompetitive times, regardless of size and nature, entrepreneursneed to implement certain basics to achieve their prime objectivei.e. to earn profits from the business on a continuous basis.

Four basic factors must be considered as vital signs for businesscontinuity in the long run:

� Positive financials; � Customer satisfaction; � Effective processes; and � Trained human resource & business infrastructure.

To achieve the business’s financial objectives, entrepreneursneed to have satisfied customers. To retain satisfied customershe needs to device processes which can deliver desiredproducts and services to customers on a continuous basis witha concept of customized products and services. Furthermore, toimplement these business processes business need skilledhuman resource and infrastructure to deliver the desired results.

Conclusively, if we reverse this series of factors in ascendingorder we come to know that two factors i.e. skilled humanresource and business structure, and defined processes areleading factors and if these are effectively in place then the othertwo factors i.e. customer satisfaction and positive financials areguaranteed.

Business survival is wrapped in this golden strategy of retainingexisting customers and attracting new customers withoutcompromising on quality of products and services with anensured positive bottom line. If these basic factors are properlyfollowed and implemented, rest assured the business willsurvive and thrive in good times and bad.

Aamir Jan MuhammadGeneral Manager Finance – South,

Pakistan Telecommunications Corporation Limited (PTCL).

C O V E R S T O R Y

To achieve the business’sfinancial objectives,

entrepreneurs need to havesatisfied customers. To retainsatisfied customers he needs todevice processes which candeliver desired products andservices to customers on a

continuous basis with a conceptof customized products and

services.


Introduction

Recessions are like hurricanes: they hitdifferent areas with different intensities.How a company responds will depend onhow sensitive the industry is to thedownturn and the strength of its strategicand financial positions. Therepercussions of the market meltdowncontinue to reverberate around thefinancial services sector. The financialcrises around the world in the past twoyears has been very challenging foreveryone and more so for the financecommunity.

In Pakistan, as well, the past two yearshave been challenging with deterioratingpolitical, and security conditions and anumber of economic challenges like lowGDP growth, high inflation, and massivedevaluation of the rupee. The purchasingpower of the consumer has alsodeteriorated, thus putting more pressureon companies to operate efficiently andmake value offerings. However, currentlythe GDP growth has started to improveand inflation is more controlled.

Key LearningsOne of the key learnings from the current

financial crisis was that there was toomuch focus on short term revenuegeneration rather than a more sustainablelong term approach to profit and valuecreation. The CFO can play a critical rolein promoting a more balanced approachto risk and reward. This includesstrengthening the management andcompany wide understanding of the risksand funding costs associated withparticular products and trading strategies.

New Ways of Working

Businesses need to work differently andfind new ways of working. Recession andthe turbulent times that follow offer manycompanies an ideal chance to moveahead of competitors. To seize theseopportunities major activities wouldinclude clarifying strategies, shiftingresources to core activities, aggressivelymanaging costs and cash flows,increasing revenues and margins andpreparing bold moves. Not every actionwill apply to every company. In turbulenttimes people tend to get very risk aversewhich sometimes may lead to moving thecorporate innovation portfolio exclusivelytowards short term which is relatively riskfree. In such times companies needfinancial expertise to guide them to

rebalance the portfolio, channelling someresources on innovation efforts that havethe potential to pay off handsomedividends.

Business AnalysisWhen the business environmentbecomes more uncertain there is agreater need to understand how thebusiness is performing and where it isspending the money. A lot moreinformation covering the full range ofoperations from the organization’sexposure to currency movements,information analysis on the company’ssupply chain and logistics operations, riskexposures on investment decisions, theorganization’s liquidity position, its netdebt position etc. is required.

Also in the current environment there isgreater pressure on organizations toproduce accurate and timely informationthat provides an informed view ofbusiness performance and expectedtrading conditions. The accuracy andreliability of business information hasbecome critical and the financecommunity is seen to drive value throughbetter planning and improving theaccuracy of business forecasting. The

FinancialLeadership in anAge of TurbulenceKhursheed Kotwal, FCA

C O V E R S T O R Y


need for forward looking information andmore refined business forecasting is veryessential.

The CFO and finance teams can play avery important role by making sure thatcorrect and timely analysis is done tounderstand the changing environmentand evaluate whether there is a need toreview new operating and financialmetrics in the light of the environment.

Managing CostsWhen profit margins are significant bigcompanies may not be as focused oncost- what they now need is really strongbusiness analysis to reduce the businesswaste and look for cost efficiencies incontrolling costs. In times of stability thesecompanies may not be too concernedabout costs because they have more fatin the profit margin. During a recessionaryprofit there is pressure on the margins.

The consumer is not able to pay suchprices. A proper review of supply chaincosts and alternative options ofresourcing the business should beevaluated. Under such circumstanceslooking at avenues of cost savings andbusiness efficiencies are also criticallyimportant.

Also, in a difficult economic environment,proper forecasting and planning areimportant. Because of the sharpness withwhich things decline and depending onhow deep the declines were, a lot ofcompanies around the world were forcedto make relatively abrupt and drasticmoves in order to deal with the loss ofsales and loss of volume by reducing theworkforce.

Working Capital ManagementOne of the biggest roles that the financecommunity can play is the working capital

management. As volumes decline, everyeffort needs to be made to pull workingcapital out of the system. Through a verysystematic month in month out focus onworking capital and reviews of orders andinventory levels, the focus should be onthe reordering of raw materials. Strongercontrol and understanding of workingcapital, better focus and accuracy withcash forecast position, transparency andunderstanding across the balance sheet,and debt reduction have become criticallyimportant to the survival of theorganizations.

The financial crisis has created abottleneck in the banking and cashsystem and refocused organizations onfinance operations. Cash liquidity is theprimary reason why many businesses failin the current environment which explainsthe refocus on financial operations.

Who is in a position to provide this sort of

C O V E R S T O R Y


guidance to the business? It is the financecommunity that can with its insights,knowledge and acumen be able to helpchalk out a clear direction.

Empowerment & ChallengesIn many firms the finance teams may lacksufficient licence, willingness andacceptance to challenge businessdecisions. Encouraging this vital input willrequire the mandate of the board.Effective transparency, scrutiny andoversight are essential in maintaining thechecks and balances needed tosafeguard the business and ensuresustainable returns. Empowerment tochallenge exposures even if it goesagainst the prevalent strategic thinking isimportant.

Risk ManagementIt is the finance community’s responsibilityto balance desired profit with acceptablelevels of risk. Hence, quantifying the riskand the ability to evaluate andcommunicate the risk requires developingnew processes to mitigate the risk quicklyand efficiently. These are areas where theCFO can add value to the business.

Effective ControlEffective control demands the ability tocut through the complexity and recognizedangerous exposure and flawed tradingstrategies. If the finance team hasreservations about decisions they shouldhave the necessary mandate, confidenceand ear of senior management tochallenge them.

Performance & RewardGearing compensation packages toprocess improvement and sustainabledelivery of goals could accelerateturnaround time and free time for greaterstrategic input. Finance heads & teamscan play a role in the long termdevelopment of systems for aligningcompensation to risk adjusted measuresand longer term value creation to protectshareholder value. They are instrumentalin encouraging the right behaviour bydeveloping Balanced Scorecards andmonitoring performance. This encourageseveryone to pull together and helps toembed a culture of sustainable businessgrowth and profitability.

Competence/ ChallengesThe recent financial crises have raisedquestions about whether the financeprofessionals understand enough aboutthe technicalities and risks associatedwith today’s complex structured products

to provide the necessary advice,oversight and business challenge.

Better understanding would certainlyimprove the finance team’s ability torecognize threats and identifyopportunities while ensuring their inputis taken seriously by boards andbusiness teams. There are growingtalent shortages and, therefore, itwould be unrealistic to expect financepersonnel to have comparabletechnical know how to front officeteams across all business areas. Agood CFO should be able to seethrough the complexity and be willingto challenge trading teams if theybelieve the company is facingunacceptable risks. This calls for theCFO and his team to have anenquiring mindset and probinganalytical skills.

A key consideration is whether someof the complexity that has grownaround certain products is necessarylet alone beneficial. If a qualifiedfinance professional cannot fathom theintricacies and related jargonsurrounding a particular product, thenit may not be a safe enough betanyway. This underlines theimportance of finance’s involvement inproduct development and investmentstrategies from the outset. A key partof this input should be helping to setkey parameters and looking at how torealize sustainable trading profitsrather than simply pursuing short termmark to market gains. Hence, in suchcases the CFO should hire accountingspecialists who are often embedded intrading teams to help structure deals.

ConclusionIn summary, the role of the CFO, inaddition to finance areas, cuts rightacross the organization. They are focusedon short term survival, navigating thebusiness through economic turmoil,ensuring the organization’s financeoperations are strong, and making surecustodial issues- controls framework,protection of business assets, capitalstructures - are effective. They recognizethe growing importance of strongregulatory controls, maintaining investorconfidence and relations. They continueto balance these demands while steeringorganizational strategy and ensuring thatthe finance teams provide the rightanalysis and information that the businessrequires.

Khursheed Kotwalhas recently started her own financial and

management consultancy.

C O V E R S T O R Y

The recent financial criseshave raised questions

about whether the financeprofessionals understand

enough about thetechnicalities and risksassociated with today’scomplex structured

products to provide thenecessary advice,

oversight and businesschallenge.


No Strategy Without Operations:

C O V E R S T O R Y

Operations activities must support corporate strategy if firmsaspire to gain competitive advantage

PART IFACTS OF THE CASEStarware International is engaged in the manufacturing and saleof a range of good quality household and commercial ceramicware. In addition to the local market the company exports tocustomers like Harrods in the United Kingdom, IKEA in theUnited States, CIS and Central Asia.

The factory handles ceramic production from the initial processof grinding minerals for formulating various color glazes to thefinal firing with decals decoration.

Starware International has a multi-source, single layer supplychain with a focus on price. Regular raw materials such as clay,grinding minerals, color glazes, decal and packing material arepurchased from several independent local suppliers on longterm contracts with an agreed price for a minimum period of oneyear. For import of a specified German chemical product, thecompany has a long standing relationship with four shortlistedalternate suppliers with C & F price included.

Typical to most developing countries Starware employsintermediate technology with production methods alternatingbetween capital and labor intensive processes.

There is a lot of emphasis at Starware on the integration ofquality within the management system, especially in terms of

bringing the end product to the customers. However, there arealso challenges that the firm faces in the successfulimplementation of Total Quality Management such as availabilityof resources, unrealistic business objectives, and establishmentof effective supplier channels.

Country factors also affect the plant’s operational capability.Manufacturing is constantly disrupted owing to major powerbreakdowns, plant breakdown, and labor unrest.

Operational Practices at Starware InternationalI. THE BULLWHIP EFFECT One dimension of the supply chain is the Bullwhip Effect whichderives its name from the action of a whip where the end movesfaster than the handle. It is the repetition of over and undersupply of materials down the supply chain causing majorproblems in coordinating the network.

Starware operations are marred by the Bullwhip Effect owing to:

a) Under supply Chemical shipments are stuck in customs for weeks. Thisdelays arrival of goods to the manufacturing plant by severaldays. Frequently, furnished material is out of specificationand has to be rejected.

b) Over supplyMaster production schedule (MPS) goes off target loweringmaterial consumption, ultimately resulting in excessinventory.

II. PROBLEMS IN PRODUCTION CONTROL Starware’s production system is one of mass customization,producing low cost, high quality outputs in high variety. The corecapabilities of Starware are focused on cutting costs bypromoting efficiency and producing high quality product at lowunit cost.

Starware’s production control system is material requirementsplanning (MRP) where work and material are pushed through to

No Strategy Without Operations:Rana Mustansir

A Simulated Case Study of Starware International

A multi-source, single layer supply chain means:• the manufacturer has many suppliers for the same part so

sources can be switched in case of supplier failure;• the suppliers are played off against each other which

means the purchaser (manufacturer) can drive downprices through competitive tendering;

• the manufacturer is the dominant party


try and pre-empt demand, as opposed to Just-in-Time (JIT)which operates with work instructions deriving from customerdemand which pulls material through the system.

The firm is able to customize its product range to suit the needsof different customer groups without a cost penalty. Yet,production at Starware suffered from:

a) Over-production Production in Starware was for more than what was required(large lot production) and before it was required (pushproduction). Over-production results in higher storage costs,excessive lead times, and makes detecting defects quitedifficult.

b) Waiting The plant experienced waiting when goods were not movingdue to poor material flow and long production runs, as whena production order was waiting for machine availability.

c) Unnecessary Inventory As a direct result of overproduction and waiting, the plant hadexcessive inventory which lead to increased lead times andlimited floor space. Batch processing caused inventory influx.The push system left excessive finished goods and work inprocess, and buffers between unsynchronized productionoperations.

d) Product DefectsDefects occurred in internal production, in supplierparts/materials, during final testing, and would be discoveredby customer after delivery.

PART II ANALYSIS OF THE CASE

Operations Management is a Strategic ActivityIn a 1997 study researchers Sven Horte and Hakan Ylinenpaafound that favorable sales performance resulted when there wasa good fit between a firm’s and its customer’s perception of thestrengths of a product. Conversely, when firms had high opinionsabout their competitive strengths but their customers did notshare this opinion, sales performance was negative.

That was exactly the case with Starware International. The plantwas running under capacity due to tough competition and lowmarket penetration caused by high flow of Chinese finishedproducts at comparatively very low prices. Cost of production atthe plant was very high owing to high materials and energycosts, high rupee dollar parity, and import duties and tariffs onraw material. Still the plant continued to manufacture a productthat the buyer did not want. Thus, the firm showed great skill inmaking a product for which there was little demand.

During the 1970s and 1980s, global markets had become socompetitive that firms began to reevaluate their manufacturingstrategies on the basis of the four competitive priorities: cost;quality; delivery/service; and flexibility. They realized that insteadof making tradeoffs on these priorities they could compete onseveral competencies.

The term ‘world-class’ manufacturing emerged in the 1980sfollowing the 1986 publication of World Class Manufacturing:The Lessons of Simplicity Applied by Richard J. Schonberger. Acompany was said to be world-class if it had the ability to

compete in a global market. At this time Japanese techniqueswere having a huge impact on manufacturing. The ToyotaProduction System (TPS) had become the flag bearer ofoperational efficiency. TPS was established based on twoconcepts:

i) The first is called jidoka, loosely translated as ‘automationwith a human touch’ which means that quality must be builtin during the manufacturing process such that when aproblem occurs, the equipment stops immediately preventingdefective products from being produced.

ii) The second is the concept of Just-in-Time (JIT). Making onlywhat is needed, when it is needed, and in the amountneeded so that each process produces only what is neededby the next process in a continuous flow.

Based on the basic philosophies of jidoka and Just-in-Time,Toyota was efficiently and quickly producing vehicles of soundquality, one at a time, to fully satisfy customer requirements.

By 1990, management guru Peter Drucker had postulated that inthe modern manufacturing era, world class will be based onStatistical Quality Control, a flexible manufacturing system, anintegrated supply chain, and manufacturing economics.

Based on that hypothesis, small and medium sized businessesin developing countries need to acquire additional capabilities inorder to compete in the international business arena: managingin scarce supply conditions; identifying local supply sources; andtraining unskilled and semi-skilled workers. Local firms likeStarware could become world-class if they understand that whatthey need is an enduring approach to competition.

However, to become truly world class firms like Starware willhave to broaden their capabilities to include such factors as theestablishment of strong brands, economies of scale, and marketdominance.

The goal of Starware’s manufacturing strategy should not be tomake short-term choices between cost, quality and flexibility, butto differentiate itself from its competitors through innovation andbuilding on the firm’s unique skills and capabilities.

That would be possible only when it starts to view operations asa strategic activity. The operations strategy must be designed insuch a way that all decisions relevant to system design,planning, control and supervision work to accomplish themanufacturing mission of the company.

As Harvard University researchers Hayes and Pisano say, ‘Acompany should think of itself as a collection of evolvingcapabilities, not just as a collection of products and businesses.’

This case study was developed as part of an InternationalOperations Management module for Royal Holloway College,UK. It has been adapted for The Pakistan Accountant.

Drucker, Peter E. “The Emerging Theory of Manufacturing,” Harvard BusinessReview, May-June 1990, pp. 94-102.

Hayes R. and Pisano, G. (1994) “Beyond World-Class: The New ManufacturingStrategy” in Harvard Business Review, January-February, pp.77-86.

Horte, Sven Ake, and Ylinenpaa, Hakan,( 1997), The firm’s and its customers’views on order-winning criteria, International Journal of Operations and ProductionManagement, Volume 17, Issue 10

C O V E R S T O R Y


Introduction The operational modalities of collective investment schemesmore commonly referred to as mutual funds and the presenceof some peculiar requirements of the Non Banking FinanceCompanies and Notified Entities Regulations, 2008 (NBFCRegulations) poses some accounting issues which are normallynot encountered in the limited liability companies.

In this article we will try to critically analyze the accountingtreatment of the following issues that are prevailing in themutual funds in Pakistan:

� Element of Income and Capital Gains (specific to openended funds only)

� Compulsory distribution of ninety percent of the accountingincome to the equity participants of the mutual funds(applicable to open ended funds, closed end schemes andinvestment companies)

ELEMENT OF INCOME AND CAPITAL GAINSAs most of the readers of this journal are aware that open endedmutual funds continuously offer their units for sale and similarlythese units can be redeemed at any time and in this aspect

these open ended funds are different from a limited liabilitycompany where the share capital once issued is not repayablein the normal course, and the same are traded in the secondarymarket. This continuous entry and exit of the unit holders posesa unique accounting issue prevailing in the open ended mutualfunds in Pakistan i.e. 1the recognition of ‘Element of Income andCapital Gains (Element) included in the prices of units issuedand redeemed’ in the income statement of the open endedmutual funds.

What is Element? Before discussing the prevailing accounting treatment ofElement it is necessary to understand the nature of Element.The units of open ended funds are issued and redeemed on thebasis of Net Asset Value (NAV) which is computed by dividingthe net assets of the open ended fund by the number ofoutstanding units at any particular time. When a unit holderredeems one unit from an open ended fund the amount he getsrepresents the current values of the net assets of the openended fund which also include a portion of income and capitalgains that the open ended fund has earned till the time ofredemption. Similarly, in order to purchase one unit of openended fund a person has to pay the current values of the net

A C R I T I C A L A N A L Y S I S O F

ACCOUNTING PRACTICESPREVAILING IN THE MUTUALFUNDS IN PAKISTANMuhammad Rashid Zafer, ACA

A R T I C L E S


assets of the open ended fund which also include a portion ofincome and capital gains that the open ended fund has earnedtill the time of purchase of units. This portion of income andcapital gains that is paid and received at the time of redemptionand purchase of units respectively is termed as Element.

Current Treatment of Element in the Financial Statements of theOpen Ended FundsCurrently there are two practices that are prevailing regardingthe recognition of Element which can be summarized as follows:

Practice 1� The Element on issue of unit is recorded as income with

the corresponding effect in unit holders’ fund.

� The Element on redemption of units is recorded as expensewith the corresponding impact on unit holders’ fund.

Practice 2The Element is divided into two parts by separating the Elementthat pertains to unrealized gains that forms part of unit holders’fund (i.e. unrealized gains on available for sale financial assets)and the Element that pertains to all other income and capitalgains.

� On issue of units the Element pertaining to unrealized gainsthat forms part of unit holders’ fund is included in thedistribution statement as amount available for distributionand the Element that pertains to all other income and capitalgains is recorded as income with corresponding impacts onunit holders’ fund.

� On redemption of units the Element that pertains tounrealized gains that forms part of unit holders’ fund isincluded in the distribution statement as a deduction fromthe amount available for distribution and the Element thatpertains to all other income and capital gains is recorded asexpense with corresponding impacts on unit holders’ fund.

The reason for this bifurcation of Element is that since theunrealized gains on available for sale financial assets do notimpact the income statement therefore, the impact of Elementthat pertains to unrealized gains on available for sale financialassets should also not be taken in the income statement.

Why Element is Recognized? The Element is recognized in order to prevent the dilution ofincome and distribution of income already paid out onredemption. To further elaborate this, suppose that onredemption from open ended fund a person gets Rs.101 in whichRe.1 represents the income and capital gains earned by theopen ended fund. If this Re.1 is not recorded as an expense theincome statement will show Re.1 as profit and at the time ofdistribution it will be distributed to the unit holders despite thefact that this Re.1 has already been paid to the unit holder onredemption. Similarly, a person pays Rs.101 for one unit of theopen ended fund in which Re.1 represents the amount of incomealready earned by the mutual fund. If this Re.1 is not recorded asincome in the income statement the amount of profit available fordistribution to the existing unit holder will dilute as one additionalunit has been issued which will participate in the income of theexisting unit holder. The following illustrations will help tounderstand the impact of Element on the financial statements:

EXAMPLE 1 - WITHOUT RECOGNITION OF ELEMENT

Net Assets & NAVDate Net assets Units NAV1-Jan-09 1,000 10 100 2-Jan-09 1,010 10 101 Issuance of Units 202 2

1,212 12 101 Redemption of Units (101) (1)

1,111 11 101

INCOME STATEMENT

Income & Capital Gains 10.00

Distributable Income Per Unit Before Issuance and Redemption of Units (Rs.10÷10) 1

Distributable Income Per Unit After Issuance but Before Redemption of Units (Rs.10÷12) 0.83

Distributable Income Per Unit After Redemption but Before Issuance of Units (Rs.10÷9) 1.11

UNIT HOLDERS' FUND

Opening Net Assets 1,000 Issuance of Units 202 Redemption of Units (101)

1,101 Net Income 10 Net assets 1,111

In the above example, if distribution of profit is made on Jan 02,2009 before the issuance and redemption of units then Rs.10 willbe available for distribution and each unit holder will get Re.1.However, if two units are issued (ignoring the redemption) the

The Element is recognizedin order to prevent thedilution of income anddistribution of incomealready paid out on

redemption.

A R T I C L E S


amount available for distribution on Jan 02, 2009 will be Rs.10whereas the number of units will have been increased from 10 to12 as a result the per unit distribution will be Re.0.83 whichresults in dilution of income available for distribution to theexisting unit holders due to issuance of two new units. Similarly,if one unit is redeemed (ignoring the issuance of units) on Jan02, 2009 the amount available for distribution will be Rs.10 andif distribution is made on Jan 02, 2009 each unit holder willreceive Rs.1.11 whereas actually Rs.9 should have beendistributed to the unit holders i.e. Re.1 per unit as the portion ofthe income attributable to one unit i.e. Re.1 has already beenpaid to the unit holder at the time of redemption.

EXAMPLE 2 – WITH RECOGNITION OF ELEMENT

Net Assets & NAVDate Net assets Units NAV1-Jan-09 1,000 10 100 2-Jan-09 1,010 10 101 Issuance of units 202 2

1,212 12 101

Redemption of Units (101) (1) 101 1,111 11 101

INCOME STATEMENT

Income & Capital Gains 10 Element of Income on Issuance of Units 2 Element of Income on Redemption of Units (1)

11

Distributable Income per Unit BeforeIssuance and Redemption of Units (Rs.10÷10) 1

Distributable Income per Unit AfterIssuance but Before Redemption of Units (Rs.12÷12) 1

Distributable Income per Unit AfterRedemption but Before Issuance of Units (Rs.9÷9) 1

UNIT HOLDERS' FUND

Opening Net Assets 1,000 Issuance of Units 202 Redemption of Units (101)Element of Income on Issuance of Units (2)Element of Income on Redemption of Units 1 Net Income 11Net assets 1,111

In the above example, if distribution of profit is made on Jan 02,2009 before the issuance and redemption of units then Rs.10 willbe available for distribution and each unit holder will get Re.1. Iftwo units are issued (ignoring the redemption) the amountavailable for distribution on Jan 02, 2009 will be Rs.12 whereasthe number of units will have been increased from 10 to 12. Asa result the per unit distribution will remain same and no dilutionwill occur in the income available for distribution to the existingunit holders due to issuance of two new units. Similarly, if oneunit is redeemed (ignoring the issuance of units) on Jan 02, 2009the amount available for distribution will be Rs.9 (10-1) and ifdistribution is made on Jan 02, 2009 each unit holder will getRe.1. As a result the amount paid at redemption will not bedistributed again.

It is clear from the above that the recognition of Element isinevitable in order to enable the open ended fund to continuously

issue and redeem units without diluting the income available fordistribution to the unit holders and to prevent the distribution ofincome which has been paid to the unit holders at the time ofredemption.

Is the Current Treatment of Element in Accordance with theFinancial Reporting Framework Applicable on Open EndedMutual Funds?

Paragraph 70 of the 2Framework for the Preparation and

Presentation of Financial Statements (the Framework) definesincome and expenses as follows:

“Income is increases in economic benefits during the accountingperiod in the form of inflows or enhancements of assets ordecreases of liabilities that result in increases in equity, otherthan those relating to contributions from equity participants.”

“Expenses are decreases in economic benefits during theaccounting period in the form of outflows or depletions of assetsor incurrences of liabilities that result in decreases in equity,other than those relating to distributions to equity participants.”

Since the units of open ended funds are classified as equityinstruments in accordance with the requirements of InternationalAccounting Standard 32 therefore, in accordance with thedefinition of income and expense any contribution from ordistribution to the equity participants i.e. unit holders cannot beclassified as income or expense.

If we analyze the examples above it will be clear that theElement is created from the contributions received from theequity participants i.e. the unit holders at the time of issuance ofunits and distributions made to the equity participants i.e. the unitholders at the time of redemption of units. Therefore, theElement should not be recognized in the income statement as itfailed to meet the definition of income and expense.

In addition, paragraph 33 of International Accounting Standard32 interalia states that “If an entity reacquires its own equityinstruments, those instruments (‘treasury shares’) shall bededucted from equity. No gain or loss shall be recognised inprofit or loss on the purchase, sale, issue or cancellation of anentity’s own equity instruments…”

It will be interesting to note that the recognition of Element in theincome statement results in two different treatments for the sameitem i.e. the amount of income paid at the time of redemption(Element) is treated as expense whereas the amount of incomedistributed as dividend at the time of distribution is treated asappropriation of profits.

Here one argument can be made that since Schedule V to theNBFC Regulations which sets out the disclosure requirementsfor the financial statements of the open ended mutual funds list‘element of income and capital gains’ in the disclosurerequirements of the income statement therefore, the sameshould be included in the income statement. The answer to thisargument is that Schedule V outlines the disclosurerequirements and most readers will agree that disclosurerequirements spell out the type and contents of certaininformation that needs to be disclosed in the financialstatements. The disclosure requirements cannot be and shouldnot be construed as accounting treatment of the items of thefinancial statements. It implies that firstly we have to evaluatewhether an item meets the criteria to be included in the incomestatement or balance sheet as per the applicable financialreporting framework and once it meets the criteria the same

A R T I C L E S


should be disclosed in accordance with the disclosurerequirement. This point is further supported by the fact that incase of prevailing Practice 2 enumerated above a portion ofElement is included in the distribution statement despite the factthat as per Schedule V the element is listed in the disclosurerequirement of income statement.

In view of the above it can be safely concluded that Elementdoes not meet the definition of income or expense as it resultsfrom contributions and distributions to the equity participants i.e.the unit holders of the open ended fund. Therefore, the sameshould not be recognized as income or expense.

SUGGESTED TREATMENT OF ELEMENT

As already mentioned above, the recognition of Element is vitalfor the open ended funds. However, since it does not qualify tobe included in the income statement a question now arises as towhat should be the correct treatment of Element? The answer tothis question is very simple i.e. since the Element is basicallycontributions from and distributions to the equity participants itshould be directly included in the distribution statement or theretained earnings rather than routing through the incomestatement. The following example will help to illustrate itsapplication:

Net Assets & NAVDate Net assets Units NAV1-Jan-09 1,000 10 100 2-Jan-09 1,010 10 101 Issuance of Units 202 2 100

1,212 12 101

Redemption of Units (101) (1) 100 1,111 11 101

DISTRIBUTION STATEMENT

Income & Capital Gains 10 Element of Income on Issuance of Units 2 Element of Income on Redemption of Units (1)

Amount Available for Distribution 11

Distributable Income per Unit BeforeIssuance and Redemption of Units (Rs.10÷10) 1

Distributable Income per Unit AfterIssuance but Before Redemption of Units (Rs.12÷12) 1

Distributable Income per Unit AfterRedemption but Before Issuance of Units (Rs.9÷9) 1

UNIT HOLDERS' FUND

Opening Net Assets 1,000 Issuance of uUnits 202 Redemption of Units (101)

1,101Element of Income on Issuance of Units (2)Element of Income on Redemption of Units 1 Undistributed Income 11 Net assets 1,111

It is clear from the above illustration that the objective ofrecognition of Element, i.e. to prevent the dilution of income andto prevent the distribution of income already paid to the unitholders at the time of redemption, can be achieved byrecognizing it directly in the distribution statement while

complying with the requirements of the financial reportingframework applicable on the open ended funds.

COMPULSORY DISTRIBUTION OF PROFITS TO THEEQUITY PATICIPANTS

Regulation 63 of the NBFC Regulations interalia states that “AnAsset Management Company on behalf of a CollectiveInvestment Scheme shall, for every accounting year, distributeby way of dividend to the unit holders, certificate holders orshareholders, as the case may be, not less than ninety per centof the accounting income of the Collective Investment Schemereceived or derived from sources other than unrealized capitalgains as reduced by such expenses as are chargeable to aCollective Investment Scheme under these Regulations.”

In order to comply with the above mentioned requirement all themutual funds distribute ninety percent of the income. However,since the distribution is approved by the board of directors afterthe year end the same is treated as a non-adjusting event afterthe balance sheet date in accordance with the requirement ofInternational Accounting Standard 10. However, one thing whichis being ignored in this treatment is that the distribution of incomeis obligatory and not at the discretion of the mutual funds asspecified in the above mentioned Regulation. This element ofobligation on the mutual funds meets the definition of liability asstipulated in the Framework which defines liability as “A liabilityis a present obligation of the entity arising from past events, thesettlement of which is expected to result in an outflow from theentity of resources embodying economic benefits.” Further,paragraph 60 of the Framework interalia states that “Anessential characteristic of a liability is that the entity has apresent obligation. An obligation is a duty or responsibility to actor perform in a certain way. Obligations may be legallyenforceable as a consequence of a binding contract or statutoryrequirement.”

It is clear from the above that in case of income, compulsorydistribution of ninety percent income is a present obligation ofthe mutual funds enforced on it by the NBFC Regulations and asevident it will result in outflow of resources embodying economicbenefits therefore, the same should be accounted for as liabilityand should not be treated as a non-adjusting event after thebalance sheet date.

Further, if we analyze the offering documents of the mutual fundswe will note that almost all the mutual funds, in some form or theother, have specifically stated in their offering documents thatninety percent of the income will be distributed to the equityparticipants in order to avail the benefit of tax exemptionavailable under Clause 99 Part 1 of the Second Schedule to theIncome Tax Ordinance 2001, which interalia requires that anyincome derived by a mutual fund shall be exempt from tax if notless than ninety per cent of its accounting income of that year, asreduced by capital gains whether realized or unrealized, isdistributed amongst the equity participants. For the convenienceof readers following is an extract from the offering document of amutual fund:

“Notwithstanding the tax rates stated under Clause XXX above,the accounting income of the Fund will be exempted from tax ifnot less than 90% of the accounting income of the accountingperiod is distributed amongst the Unit Holders. The 90% of theaccounting income shall be calculated after excluding capitalgains whether realised or unrealised. XXX Fund will seek tocomply with the requirements of tax exemption and distribute atleast 90% of the accounting income, calculated after excludingcapital gains to the Unit Holders.”

A R T I C L E S


3International Accounting Standard 37 (IAS 37) definesconstructive obligation as:

“A constructive obligation is an obligation that derives from anentity’s actions where:

(a) by an established pattern of past practice, publishedpolicies or a sufficiently specific current statement, theentity has indicated to other parties that it will acceptcertain responsibilities; and

(b) as a result, the entity has created a valid expectation onthe part of those other parties that it will discharge thoseresponsibilities.”

If we analyze the above statement of the offering document inlight with the definition of constructive obligation it will be clearthat the above statement creates a constructive obligation on themutual fund to distribute ninety percent of the accounting incomeand Para 14 of IAS 37 interalia requires that a provision shall berecognized when an entity has a present obligation (legal orconstructive) as a result of a past event.

From the above discussion it is clear that distribution of ninetypercent income creates an obligation on the mutual funds whichneeds to be recognized as a liability or as a provision on thebalance sheet however, in case of open ended funds since theunits are issued and redeemed on a continuous basis therecognition of compulsory distribution as a liability may createissues in the issuance and redemption of units on the basis ofNAV. For example if an open ended fund started its operationfrom Rs.100 and on the next day it earned Re.1 as profit the NAV

on the next day will be Rs.101 (assuming only one unit holder).However, if we record liability for distribution of ninety percentincome the NAV will be Rs.100.1 only. If the unit holder redeemshis units he will get only Rs.100.1 whereas actually he shouldreceive Rs.101.

In view of the above it is suggested that a joint committee of TheInstitute of Chartered Accountants of Pakistan and the MutualFund Association of Pakistan should be formulated to considerthe issue in order to formulate a solution which caters to theoperational modalities of the open ended funds while complyingwith the applicable financial reporting framework.

D I S C L A I M E R : The views expressed in this article are solely my personal

views and not of the company I represent.

1For the sake of simplicity the Element of loss and capital lossis not discussed in this article.

2International Financial Reporting Standards Bound Volume2007

3International Financial Reporting Standards Bound Volume2007

Muhammad Rashid Zafer Senior Manager Trustee & Custodial Operations with the Central Depository

Company (CDC) of Pakistan Limited. Readers can contact him [email protected]

A R T I C L E S

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Pakistan is one of over 80 countries with plans in placeto issue IPSAS (International Public SectorAccounting Standards) or IPSAS-similar financialstatements within its public sector. Pakistan is beingsupported financially by the World Bank as it

attempts as a first step to meet the requirements of the cashbasis IPSAS before eventually progressing towards producingfull accruals based financial statements within its public sector.

Long-term sustainability of public finances The IPSAS Board is the body responsible for setting accountingstandards in the public sector. While it aims for convergence withInternational Financial Reporting Standards issued by theInternational Accounting Standards Board, full convergence isimpossible because of the unique nature of the public sector.

An example of a difference between public and private sectorfinancial reporting needs can be demonstrated through therecent release of an IPSAS Board consultation paper whichlooks at “Reporting on the Long-Term Sustainability of PublicFinances”.

Inter-generational fairness of fiscal policyReporting on the long-term sustainability of public financesinvolves an examination of the extent to which a government’spolicies under its current legal framework can be met in thefuture, assuming certain fiscal constraints, principally related tolevels of taxation. The issues addressed in the paper arebecoming increasingly of interest as people become more awareof concepts such as the “inter-generational fairness” of fiscalpolicy which means that our children and their children willultimately bear the cost for fiscal decisions taken today.

An example of the inter-generational fairness of fiscal policyinvolves the costs associated with an ageing population. As life

expectancy increases it is becoming increasingly onerous forcountries to pay the nationally funded pension benefits andhealthcare costs of its ageing population. In response to thecosts associated with an ageing population many countries areexploring ideas of delaying the age when its citizens can receivenationally funded pensions in an effort to reduce costs. One canalso consider the effects of the recent worldwide credit crisis andthe cost incurred by many governments in bailing out theireconomies, and in particular their banks; who will ultimately bearthese costs and when?

Clearly taxpayers and investors have an interest in long-termfiscal sustainability and how it will be funded, as does the IPSASBoard which believes that public sector financial reports shouldinclude both historical looking financial statements as well as“prospective financial and other information about the reportingentity’s future service delivery activities and objectives, and theresources necessary to support those activities”.

Benefits of long-term sustainability reportingCurrently many countries issue long-term sustainabilitypredictions looking from 50 to 75 years into the future. Suchpredictions are typically carried out by economists, statisticians,and budget and policy specialists working in their nationalMinistries of Finance or Treasuries.

To a large extent long-term sustainability reports should prove tobe more interesting to most people than historic looking financialstatements. While historic financial statements typically cover asingle year and are subject to variations in the short-termeconomic cycle, forward looking predictions will help smooth outthe peaks and troughs of economic cycles. From a fiscalperspective governments can cover short-term fiscal deficitsthrough borrowing, but over the long-term the chances offunding continuous fiscal deficits through borrowing reduces,

Reporting on theLong-TermSustainability ofPUBLIC FINANCESIan Sanderson FCA (E&W)

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and governments must takethe unpopular political decisionto raise taxation. To be mostbeneficial long-termsustainability reporting shouldbe based on currentgovernment policy; this willallow stakeholders to see thelong-term effect of currentpolicies and anticipate whatremedial action must be put inplace to create a balanced setof accounts in the long-term.

Practical issuesThere are practical difficultiesin producing reliable long-termfiscal sustainability reports, themost obvious being thereliability of estimates thatreach well into the future. Evenwhen producing historicallooking financial statements akey difficulty is the estimation ofprovisions where an entity hasa present obligation as a resultof a past event, such as payingthe pensions of currentlyemployed staff. Under long-term sustainability reportingestimates are taken a stepfurther. You must estimate thefuture costs (e.g. health,welfare, pension) of apopulation which may not yetbe born, and then try toestimate the tax that will bepaid by that same hypotheticalpopulation.

Although the future is hard, ifnot impossible, to predict theinformation to be included inlong-term financial sustainability reports must still have thequalitative characteristics necessary to achieve the financialreporting objectives of holding people accountable for decisiosmade and for making optimal resource allocation, political andsocial decisions. The IPSAS Board considers the qualitativecharacteristics of financial reporting to be relevance, faithfulrepresentation, timeliness, understandability, comparability andverifiability. It becomes more difficult to attain thesecharacteristics the longer you look into the future.

Verifying the futureJust how do you verify what will happen in the distant future?Future government revenues and costs are based on numerousfactors revolving around the relationship between labour andcapital. In terms of labour, how productive will it be in the future?What will future fertility and mortality look like, will people moveto, or leave the country? In terms of capital how productive will itbe in the future - how much more technologically advanced willthe world become? Then there are other factors which will havean impact on productivity – how much will climate change andwhat will be its environmental impact upon economic growth?

In the United Kingdom, the Comptroller and Auditor General isrequired to, “examine and report on conventions andassumptions underlying the Treasury’s fiscal projections that are

submitted to me by theTreasury for examination” inthe government’s annualbudget. This examinationincludes looking at factorsused in estimates such as thetrend rate of growth and thenconcluding on them. At leastan independent review andexamination gives a littlemore comfort in the reliabilityof information presented.

However, in many developingcountries issues ofverification will prove moredifficult to address becausefuture growth patterns maybe harder to estimate and theinfrastructure required toproduce and validate long-term fiscal models may notcurrently exist.

Comparing like-with-likeThere are also interestingtechnical issues thatsurround the qualitativecharacteristic of comparabilitywhen producing long-termsustainability reports. Manygovernments producefinancial statements whichare based on the concept ofcontrol. From a financialreporting perspective controlrequires the demonstration ofboth the power to govern thefinancial and operatingpolicies of another entity (atleast at the strategic level)and to benefit from theactivities of another entity.

However, in long-term fiscal sustainability reporting the conceptof control is often absent; many government entities which maynot be strictly under the control of government (such as utilityproviders) will appear in sustainability reports. This means thatcomparing historical financial statements with long-term financialpredictions is not comparing like-with-like.

Improved future decision makingFor many people the question of whether long-term sustainabilityreports should appear together with historical financialstatements is probably an irrelevance. Many people andinvestors, especially in developing countries, would simply like tohave access to reliable long-term sustainability projections whichwill allow them to make better informed personal or businessdecisions. While historical financial statements are used foraccountability purposes, forward looking financial reports havethe much more interesting potential to effect the life decisions ofindividuals.

Ian SandersonFellow of the Institute of Chartered Accountants

in England and Wales

Clearly taxpayers and investors have an interestin long-term fiscal sustainability and how it will

be funded, as does the IPSAS Board whichbelieves that public sector financial reports

should include both historical looking financialstatements

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1. THE SCOPE OF AN AUDIT OF SEPARATEFINANCIAL STATEMENTS ARISING FROM THEREQUIREMENTS OF COMPANIES ORDINANCE, 1984

Section 255 of the Companies Ordinance, 1984 requires theauditor to make a report on the company’s financial statementsto the shareholders that must state whether they have obtainedall the information and explanations which to the best of theirknowledge and belief were necessary for the purposes of theaudit and that whether, in the auditor’s opinion:

� proper books of accounts as required by the CompaniesOrdinance, 1984 have been kept by the company;

� the financial statements are in agreement with the booksof accounts as referred above and have been preparedin accordance with the requirements of the CompaniesOrdinance, 1984;

� the financial statements give a true and fair view of thecompany’s state of affairs, its profit or loss and itscashflows and changes in equity in accordance with theapproved accounting standards as applicable in Pakistan;

� the expenditure incurred during the year was for thepurposes of the business;

� the business conducted, investments made andexpenditure incurred during the year were in accordancewith the objects of the company; and

� Zakat deductible at source under the Zakat and UsherOrdinance, 1980 (XVIII of 1980), was deducted by thecompany and deposited in the Central Zakat Fundestablished under section 7 of that Ordinance.

The Companies Ordinance, 1984 requires the auditor to prepareAuditor’s Report in accordance with Form – 35A which mandatesthe auditor to conduct the audit in accordance with therequirements of the International Standards on Auditing asapplicable in Pakistan.

2. THE REQUIREMENTS OF THE INTERNATIONALSTANDARDS ON AUDITING (ISAS) AND THE ICAPREGARDING CONDUCT OF AUDIT OF THESEPARATE FINANCIAL STATEMENTS

2.1 Overall objectiveIn conducting an audit of financial statements, the overallobjectives of the auditor is to obtain reasonable

assurance about whether the financial statements as awhole are free from material misstatement, whether dueto fraud or error in order to express an opinion on thetruth and fairness of the financial statements.

2.2 Compliance with ISAs and ICAP Code of EthicsThe auditor is required to comply with:

a. all ISAs and International Auditing PracticeStatements (IAPs) that are relevant to the audit; and

b. ICAP Code of Ethics of Chartered Accountants.c. Other pronouncements issued by ICAP like ATRs etc.

ISAs require the auditor to plan and perform an audit withprofessional skepticism recognizing that circumstancesmay exist that cause the financial statements to bematerially misstated.

ISAs and the Code of Ethics contain basic principles andessential procedures together with related guidance suchas the following.

� Planning� Understanding the company and its environment

(including internal controls) � Identifying and assessing the risks of material

misstatement through understanding the company’sinternal control system.

� Responding to assessed risks by determining thenature, timing and extent of audit procedures.

� Materiality considerations in planning and performingthe audit.

The nature of these Standards requires an auditor toexercise professional judgment in applying them.Moreover, ISAs establish requirements in relation tothose areas of the auditor’s work where it is particularlyimportant that the views of auditors and users of financialstatements, regarding the nature and extent of work to beperformed, are aligned. Such areas include:

� Going concern. � The auditor’s responsibility to consider fraud in an

audit of financial statements. � Consideration of laws and regulations in an audit of

financial statements.

Muhammad Asif Iqbal, FCA

AUDITOR’SREPORT INPAKISTAN

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2.3 Scope of an audit of financial statementsAn audit involves performing procedures to obtain auditevidence about the amounts and disclosures in thefinancial statements. The procedures selected dependon the auditor’s judgment, including the assessment ofthe risks of material misstatement of the financialstatements, whether due to fraud or error. In makingthose risk assessments, the auditor considers internalcontrol relevant to the entity’s preparation and fairpresentation of the financial statements in order todesign audit procedures that are appropriate in thecircumstances, but not for the purpose of expressingan opinion on the effectiveness of the entity’s internalcontrol. An audit also includes evaluating theappropriateness of accounting policies used and thereasonableness of accounting estimates made bymanagement, as well as evaluating the overallpresentation of the financial statements.

3. OPINION ON THE FINANCIAL STATEMENTS

The opinion on the financial statements should be based on areview and assessment of the conclusions drawn on the auditevidence obtained during the audit work.

The audit report as prescribed by ISAs should:

� Contain a clear written expression of opinion on thefinancial statements taken as a whole.

� Have an appropriate title.� Be appropriately addressed as required by the

circumstances of the engagement and localregulations (if any).

� Identify the financial statements of the entity that havebeen audited, including the date of and periodcovered by the financial statements.

� Include a statement that the financial statements arethe responsibility of the entity’s management and astatement that the responsibility of the auditor is toexpress an opinion on the financial statements basedon the audit.

� Describe the scope of the audit by stating that theaudit was conducted in accordance with ISAs andother relevant local laws.

� Include a statement that the audit was planned andperformed to obtain reasonable assurance aboutwhether the financial statements are free of materialmisstatement.

� Describe the audit as including:

Examining, on a test basis, evidence to supportthe financial statement amounts and disclosures.Assessing the accounting principles used in thepreparation of financial statements.Assessing the significant estimates made bymanagement in the preparation of the financialstatements.Evaluating the overall financial statementpresentation.Include a statement that the audit provides reasonable basis for the opinion.Clearly state in the audit opinion that the financialstatements give a true and fair view (or arepresented fairly, in all material respects) inaccordance with the financial reporting frameworkand, where appropriate, whether the financialstatements comply with statutory requirements.

� The report should be dated as of the completion dateof the audit which should not be before the financialstatements are approved by the Board of Directors.

� Since auditor’s responsibility is to report on thefinancial statements as prepared and presented bymanagement, the auditor should not date the reportearlier than the date on which the financial statementsare signed or approved by management.

� The report should be signed in the name of the firmalongwith the name of the engagement partner.Additionally, the report should contain the date andplace of the signing auditor(s).

3.1 Unqualified opinionAn unqualified opinion should be expressed when theauditor concludes that the financial statements give atrue and fair view (or are fairly presented, in all materialrespects), in accordance with the identified reportingframework.

3.2 Modified Opinions

3.2.1 Matter of emphasis� In certain circumstances, the audit report may be

modified by adding an emphasis of matter paragraphto highlight a matter affecting the financial statementswhich is included in a note to the financial statementsthat more extensively discusses the matter. Theaddition of such an emphasis of matter paragraphdoes not affect the audit opinion. The paragraphwould preferably be included after the opinionparagraph and would ordinarily refer to the fact thatthe audit opinion is not qualified in this respect.

� The addition of a paragraph emphasizing a goingconcern problem or significant uncertainty is ordinarilyadequate to meet the reporting responsibilitiesregarding such matters. However, in extreme cases,such as situations involving multiple uncertainties thatare significant to the financial statements, the auditormay consider it appropriate to express a disclaimer ofopinion instead of adding an emphasis of matterparagraph.

� In addition to the use of an emphasis of matterparagraph for matters that affect the financialstatements, the auditor may also modify the auditreport by using an emphasis of matter paragraph,preferably after the opinion paragraph, to report onmatters other than those affecting the financialstatements. For example, if an amendment to otherinformation in a document containing audited financialstatements is necessary and the entity refuses tomake the amendment, the auditor should consider including in the audit report an emphasis of matterparagraph describing the material inconsistency.

3.2.2 Qualified / Adverse / Disclaimer opinionsThe auditor may not be able to express an unqualified opinion when either of the following circumstancesexists and, in auditor’s judgement, the effect of thematter is or may be material to the financialstatements:a. there is a limitation on the scope of work; orb. there is a disagreement with management

regarding the acceptability of the accountingpolicies selected, the method of theirapplication or the adequacy of financial statement disclosures.

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The circumstances described in (a) could lead to aqualified opinion or a disclaimer of opinion. Thecircumstances described in (b) could lead to a qualifiedopinion or an adverse opinion.

� A qualified opinion should be expressed when theauditor concludes that an unqualified opinion cannotbe expressed but the effect of any disagreement withmanagement, or limitation on scope is not materialand pervasive as to require an adverse opinion ordisclaimer of opinion. A qualified opinion should beexpressed as being “except for” the effects of thematter to which the qualification relates.

� A disclaimer of opinion should be expressed when thepossible effect of a limitation on scope is so materialand pervasive that the auditor has not been able toobtain sufficient appropriate evidence and accordinglyare unable to express an opinion on the financial statements.

� An adverse opinion should be expressed when theeffect of a disagreement is so material and pervasiveto the financial statements that the auditor concludesthat a qualification of the report is not adequate todisclose the misleading or incomplete nature of thefinancial statements.

� Whenever the auditor expresses an opinion that isother than unqualified, a clear description of all thesubstantive reasons should be included in the reportand, unless impracticable, a quantification of possible effect(s) on the financial statements.

� When there is a limitation of scope on the work thatrequires expression of a qualified opinion or adisclaimer of opinion, the audit report should describethe limitation and indicate the possible adjustments tothe financial statements that might have beendetermined to be necessary had the limitation existed.

� Where the auditor disagrees with management aboutmatters such as the acceptability of accountingpolicies selected, the method of their application, orthe adequacy of disclosures in the financialstatements, if such disagreements are material to thefinancial statements, the auditor should express aqualified or an adverse opinion.

The table below (as given ISA 705-A1) illustrates howthe auditor’s judgment about the nature of the mattergiving rise to the modification, and the pervasivenessof its effects or possible effects on the financialstatements, affects the type of opinion to beexpressed.

Nature of Matter Giving Auditor’s Judgment about the PervasivenessRise to the Modification of the Effects or Possible Effects on the

Financial StatementsMaterial but Not Pervasive Material and Pervasive

Financial statements are Qualified opinion Adverse opinionmaterially misstatedInability to obtain sufficient Qualified opinion Disclaimer of opinionappropriate audit evidence

3.2.3 Going Concern The report should be modified by adding a paragraph tohighlight a material uncertainty regarding going concernof the entity. However, in the following circumstances, theauditor should express a qualified or adverse opinion, asappropriate:

� If adequate disclosure about the going concernuncertainty is not made in the financial statements,

the auditor should express a qualified or adverseopinion as appropriate.

� If the auditor concludes that the going concernassumption used in the preparation of the financialstatements is inapprpropriate and therefore the financial statements are misleading, the auditorshould express an adverse opinion (ISA 570).

4. COMMUNICATING WITH THOSE CHARGED WITHGOVERNANCE

ISA 705 (paragraph 28) requires that when the auditor expectsto modify the opinion in the auditor’s report, the auditor shallcommunicate with those charged with governance (Board ofDirectors) the circumstances that led to the expectedmodification and the proposed wording of the modification.

As explained under ISA 705-A25, communicating with thosecharged with governance the circumstances that lead to anexpected modification to the auditor’s opinion and the proposedwording of the modification enables:

a. The auditor to give notice to those charged withgovernance of the intended modification(s) and thereasons (or circumstances) for the modification(s);

b. The auditor to seek the concurrence of those chargedwith governance regarding the facts of the matter(s)giving rise to the expected modification(s), or toconfirm matters of disagreement with management assuch; and

c. Those charged with governance to have opportunity, where appropriate, to provide the auditorwith further information and explanations in respect the matter(s) giving rise to the expectedmodification(s).

5. SUMMARY

5.1 Audit opinion

When the auditor issues an audit opinion, the auditorconsiders which type of audit opinion is appropriate in aparticular situation. The following flow chart endeavors toexplain the situations that need to be considered inissuing modified opinion i.e. opinion with emphasis ofmatter paragraph, qualified opinion, disclaimer of opinionor adverse opi nion.

See FLOWCHART 5.1 on Page No. 28

5.2 Matters that do affect audit opinion

When the auditor decides to issue modified opinion otherthan emphasis of matter paragraph, i.e. qualified opinion,disclaimer of opinion and adverse opinion, the auditorneeds to consider the following in each of these modifiedopinions issued:

� Criteria on which modified audit opinion is issued� Requirements of qualification paragraph� Appropriate place of qualification paragraph in audit

opinion� Impact of qualification paragraph on other paragraphsof audit opinion

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A R T I C L E S

The above are described in the table below:

Matters that Do Affect OpinionEffect of the matter is material to the F/S

5.3 Going concernWhen the auditor concludes that going concern issueexists, the auditor satisfied himself whether emphasis ofmatter paragraph is sufficient or the auditor needs toissue qualified opinion, disclaimer of opinion or adverseopinion. The decision is based on the situation. Thefollowing table lists the criteria, requirements ofqualification paragraph, disclosure required in thefinancial statements, appropriate place of qualification inaudit opinion and impact of qualification on otherparagraphs of the opinion.

See FLOWCHART 5.3 on Page No. 29

5.4 Emphasis of matter paragraph for other than goingconcern problem

Following table shows the criteria, requirements ofqualification paragraph, its appropriate place in the auditopinion and impact on other paragraphs of the opinion.

Other than Going Concern ProblemEmphasis of matter paragraph

Criteria • Significant uncertainty exists andwhose resolution is dependentupon future events that may affectF/S

• Outcome of uncertainty depends onfuture actions or eventsthat are not under direct control of the entity but may affect F/S

Qualification paragraph • Add “without qualifying our opinion”

• Highlight• The event; and• State ultimate outcome cannot bepresently determined

• No provision for any liability thatresult has been made in the F/S

Appropriate • Include after opinion paragraph andplace before other reporting responsibilityImpact on other No impactparagraphs

Muhammad Asif IqbalDirector Technical Services of ICAP

Note:

The author is extremely grateful to Mr. Usman Ghani Akbani forallowing him to reproduce section 5 of the article from hispresentation which he delivered at ICAP SMP Workshop onMarch 14, 2009. Further, the author is also thankful to Mr.Farrukh Rehman, Mr. Arslan Khalid and Ms. Farheen Mirza fortheir support in finalizing this article.

Qualified opinion Disclaimer of opinion Adverse opinion

Crteria • Disagreement withmanagement re:• acceptability ofaccounting policiesselected

• Method of their application

• adequacy of F/Sdisclosure

• Limitation on scope• Effect of disagreement orlimitation on scope not somaterial and pervasive

• Limitation onscope

• Effect of limitationon scope ismaterial andpervasive

• Disagreement withmanagement re:• acceptability ofaccounting policies selected

• method of theirapplication

• adequacy of F/Sdisclosure

• Effect ofdisagreement ismaterial andpervasive

• Disclosesmisleading orincomplete natureof F/S

Qualificationparagraph

• Clear description oflimitation on scope

• Quantification of possibleeffect unless impracticable

• Reference to moreextensive discussion innote, if any

• Indicate possibleadjustments necessary hadlimitation not existed

• Clear description oflimitation on scope

• Quantification ofpossible effectunlessimpracticable

• Reference to moreextensivediscussion in note,if any

• Indicate possibleadjustmentsnecessary hadlimitation notexisted

• Clear description ofthe disagreement

• Quantification of possible effect unlessimpracticable

• Reference to moreextensivediscussion in note,if any

Appropriateplace

• Add paragraph beforeopinion paragraph

• Add paragraphbefore disclaimeropinion paragraph

• Add paragraphbefore opinionparagraph

Impact onotherparagraphs

For limitation on scope• In auditors responsibilityparagraph add “except asdiscussed in the followingparagraph”. For limitationon scope only

• In opinion paragraph add“except for the effects ofsuch adjustment, if any, asmight have beendetermined to benecessary had we beenable to satisfy ourselves asto (state limitation)

For inappropriate accountingmethod• In opinion paragraph add“except for the effect on theF/S of the matter referredto in the paragraph so andso above” or any otherappropriate wordings onthe basis of each of thecircumstances

For inappropriate disclosure• In opinion paragraph add“except for the omission ofthe information included inthe paragraph so and soabove””

• In first paragraphchange the words“we have audited”to “we wereengaged to audit”

• Omit the sentencestating theresponsibility of theauditors

• Scope of auditparagraph omittedor amended

• Add paragraphdiscussing thescope limitation

• In place of opinionparagraph state“because of thesignificance of thematters discussedin the paragraph soand so above, wedo not express anopinion on the F/S

• In opinionparagraph add“because of theeffects of thematters discussedin precedingparagraph, the F/Sdo not give a trueand fair view”


FLOWCHART 5.1

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FLOWCHART 5.3

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Having worked for globally renowned pharmaceuticalcompanies engaged extensively in Research & Development,production of active pharmaceuticals, formulation ofpharmaceutical products, and in addition to this deploying theirresources in marketing and distribution activities, I have noticedthat there is an increasing recognition that ideas, knowledge,know-how, innovations and other intangibles are fundamentalsources of value in business. But identifying and measuring thatvalue is a complicated process with numerous non standardmodules and methods currently available to do so. In the case ofIntellectual Asset Management, Intellectual Property, a valuableform of intangible to the business and financial communities,there is particular interest in improving the consistency, qualityand usefulness of valuations.

Asia, with its conglomerates of the world’s emerging countries,has always been something of an enigma for intellectualproperty owners. On the one hand, it is one of the mosteconomically dynamic regions of the world, where increasinglyprosperous populations have more money to spend than everbefore. While on the other hand, it is also a continent in whichpiracy and counterfeiting are rife, and where, in general,governments, courts and enforcement agencies have been slowto tackle the difficulties rights owners face. The problem,therefore, is a tricky one. Should rights owners fully engage inAsian markets for the potential they offer in terms of increasedopportunities, or should they choose to stay out because of therisk that IP thieves could undermine substantial investments,while the authorities stand by and do little to help? One of theother important reasons behind this fiasco in Asia is lack ofunderstanding of the valuation of intellectual assets to a greaterextent even with the exponential increase in the impact of marketcapitalization due to the presence of intangibles.

Valuation of intellectual assets is a matter of immenseimportance to a large number of professional communities,which include business people, valuation professionals,

accountants, academics, consultants, regulators, tax authoritiesand valuation thought-leaders. But there is no generalagreement or consensus among them on how the valuation ofintangibles should be conducted. Several attempts have beenmade in the past decade to develop uniform standards of valuingintangibles but none has had a visible impact on IP valuations orhas significantly improved the quality and consistency of IPvaluation reports. Why not? What are the major issues that haveprevented the development of intellectual assets valuationstandards?

Out of the various attempts made previously to harmonize thestandard of IP valuations none were successful which can affecttheir value. With the greater understanding at hand, and giventhe importance of IP to an increasing number of businesses, itseems it is time to investigate three fundamental questionsrelating to standardizing IP valuations:

1. Does it make sense to standardize IP valuations?

2. If so, what should be the standard?

3. How valuation standards are formulated and implemented successfully?

The answers to these questions depend on the perspective ofthe person asked and the professional communities within whichthey operate. The different, and sometimes narrow, interests andfocus of each community have made it impossible for them toagree on any one standard for IP valuation. Further, thetendency of businesses to consider IP valuation mainly withinthe context of the financial accounting paradigm has been amajor obstruction to the development of believable and usefulvaluation standards.

Although standardization affects assorted communities, the onemost directly affected is the IP valuation community itself. For

COMPLEXITIES ANDABSENCE OF UNIFORMVALUATION PROCESSOF INTELLECTUALASSETS VALUATIONMohammed Hanif Ajari, FCMA

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this reason it seems reasonable to begin an examination ofstandardization through the eyes of this community. For credibleviews on the three fundamental questions above, I havereviewed the literature and material printed on this subject by therespected academics and practitioners who have madesignificant intellectual contributions to the field of intellectualproperty valuation, both in theory and in practice. This articlepresents the condensed views of a panel of experts inIntellectual Asset Management. No one from the intellectualcommunity has written all of the ideas in a single paper, althoughthere is a complete consensus on the basics. The consensus ison the need for standardized valuations.

Standards and Standardization There are two broad types ofstandards: rule-based standards andprinciple-based standards (I refer tostandards in this context to meanguidelines and definitions, such asISO9000 for quality systems andISO14000 for environment). Rule-based standards are often found inenvironments where there is both aneed and a capability to enforce thestandard. Principle-basedstandards are often used inprofessional environments wheredefinition and understanding ofaccepted professionalbehaviour enforcement is thefocus.

Traditionally, there has beena periphery betweentechnical standardsorganizations andprofessional standardsorganizations, althoughthe lines between themare beginning to smear.On the technical side,perhaps the premierorganization is the InternationalOrganization for Standardization(ISO) established to: “Facilitate theinternational coordination andunification of industrial standards.” ISOis made up of member bodies that are“most representative of standardization”in their countries. Only one organizationfrom each country is accepted for membership in the ISO. So, forexample, in the United States the member body is the AmericanNational Standards Institute (ANSI); in Canada it is the CanadianStandards Council; and in Japan it is the Japanese StandardsAssociation.

The need for an ISO standard is usually expressed by anindustry sector, which communicates this need to an ISOnational member body. The latter proposes the new standard tothe ISO as a whole. Once the need for an international standardhas been documented and formally agreed, the first phaseinvolves defining the technical scope of the future standard. Thisphase is usually carried out in working groups of technicalexperts from countries interested in the subject matter. Althoughthe ISO and its member bodies have typically focused ontechnical and industrial standards, they have more recentlybecome involved with management systems standards.

In contrast to technical standards organizations, professionalstandards organizations spotlight the ethics, methods andpractices in specific professions. Examples include theaccounting profession (in North America they are the USFinancial Accounting Standards Board (FASB), the CanadianInstitute for Chartered Accountants (CICA) and Mexico’sInstituto de Contadores Publicos); the legal profession - theprofessional standards committees of the national barassociations; and the medical profession - the professionalstandards committees of the national medical associations; toname but a few.

Each profession establishes its own standards, some relating toethics, others to methods of operation and still others to specificpractices. Unfortunately there is no specific focus on valuation

which is the core issue today.Particularly the recent meltdown inglobal finance market has authenticatedmarket capitalization directly or inverselyrelated to the presence of intangibles onthe balance sheet of the companies.

Is the IP valuation communitysufficiently organized and unified towarrant the establishment of either arule-based or a principle-based setof standards such as thosedescribed above? The IPvaluation communities haveportrayed different arguments,each with its own perspective.It is a scrappy communitypopulated by people trainedin accounting, economicsand finance; IP valuationhas not yet achieved thedegree of structurenecessary to call itself aprofession. A standardfor IP valuationdeveloped around the

context of any one of itsconstituents (accounting,

economics or finance) could beentirely wrong for the others.Standards are more easily implementedwhen they are toughened. A goodexample of underpinning is found in theCanadian accounting profession, whichuses four main sets of standards:

1. Financial reporting standards - standards for measurementand disclosure.

2. Auditing standards - dealing with matters concerning theprocess of auditing.

3. Ethical standards - a code of professional conduct foraccountants.

4. Certification standards - defining the body of knowledge andthe competencies that accountants are expected to possess.

The first two sets of standards are the responsibility of anindependent standards-setting organization and the professionitself manages the latter two. The four different categories ofstandards are mutually reinforcing. The auditing standardsreinforce the financial reporting standards; the ethical andcertification standards ensure that accountants are qualified andmotivated to live up to the financial and auditing standards since

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failure to maintain one’s knowledge or to act ethically can cut acareer short. In short, standards of practice or performance maywork best when they can be developed in recital with otherstandards that reinforce the desired conduct.

What is the generic process for valuing intangibles?Whether projecting price or worth, professionals who seek tovalue IP follow a nonspecific process. Before doing anycalculations they identify the factors that define the context of thevaluation at issue. They identify the method that will be used,the key parameters concerned, the data required for thecalculation and information about the markets, as well as anyexternal factors deemed to be relevant. Professional valuatorsrecognize that valuation is as much an art as a science, meaningthat while there are protocols andaccepted procedures (thescience), the decisions thatprecede calculation are perhapsmore essential to a successful IPvaluation activity than thecalculations themselves. Makingthose judgments (the art) isinherent in the process and mustbe considered in anystandardization procedure.

Factors identified for genericprocess of valuation are:-

1. The purpose of the valuationestimate (e.g. tax, external performance reporting, sale,licensing or litigation) as well as any purposes for which thevaluation specifically may not be used.

2. Identification of the beholder, the person from whoseperspective the valuation estimate is viewed (e.g. externalbeholders, such as potential investors, shareholders,prospective purchasers; or internal beholders, such as theCEO, the CFO, chief legal officer, licensing officer, chief R&Dofficer).

3. The definition of value used; for example, worth - value inuse to a specific beholder; or price - a historical or futureestimated selling price. Any premises that should beunderstood to affect value (e.g. whether the business is agoing concern, or has filed for bankruptcy and so on).

4. Timeframe of the value estimate (past, current or future).5. The standard of measurement (market capitalization, value

in exchange, value in an accounting framework).6. The unit of measurement (for example, currency, indices,

ratios, vectors).

Why should IP valuations be standardized?The reasons for standardizing IP valuations depend largely onthe perspective of the person asked. People outside the IPvaluation community - for example, regulators, tax authoritiesand accounting standards setters - answer differently from thoseinside it. Regulators are interested in leveling the playing field,ensuring that IP valuation information is understandable andavailable to all interested parties. Tax authorities want IPvaluations to be consistent, credible and conducted in accordwith their own standards; financial accountants need valuationsto comply with Generally Accepted Accounting Principles(GAAP) or International Financial Reporting Standards (IFRS).But professional IP valuators, people inside the IP valuationcommunity, have different concerns. The focus of IP valuationprofessionals is on improving the quality and consistency of IPvaluations; whereas the focus of those outside the community is

on ensuring that IP valuations be conducted within uniqueframeworks associated with their different perspectives and IPcontexts. The panel largely, but not unanimously, agreed that anIP valuation standardization process should be led by the IPvaluation community. The arguments for standardization areidentified as follows:

1. The need to create a common language: The terms oftenused in the valuation of intangibles are not used uniformly.The word value itself is used to mean several different things.A standard should define the relevant terminology in order toprovide clarity in communications and minimize the chancesof misunderstanding.

2. The need to improve the consistency of valuations andvaluation reports: Because there are so many methods and

so many IP valuators, withdifferent professional training andlevels of understanding, there islittle consistency in howvaluations are conducted andwhat IP valuation reports contain.Some include backgroundinformation, the sources of dataused and the details of businessjudgments. Others provide littlemore than the type of IP beingvalued and a value estimate. IPvaluation standards couldimprove consistency by definingwhat a standard IP valuationreport should contain.

3. The need to minimize unethical and incompetent valuations:Professional valuators are implicitly entrusted to use theirprofessional knowledge and skill to provide the bestvaluation estimate possible. But some intentionally abusethat trust; while others may be well-intentioned but lackknowledge and experience. Standards would help tominimize unethical and incompetent valuations by defining aset of ethical principles and behaviours to which IP valuatorsare expected to adhere.

4. The need to define required valuator knowledge: People whoare new to the field of IP valuation may lack an adequateunderstanding of the nature of IP - the special considerationsrelated to valuing IP, how IP is used in business and thedifferent kinds of value it can provide. In the absence ofstandards defining the level of knowledge and know-hownecessary for valuing IP, such people blithely enter whereothers fear to tread. A standard could require or recommenda particular level of knowledge and understanding on the partof the valuator.

5. The need to let clients and users of a valuation know what toexpect: Clients and users of valuation results should knowsomething about IP value and valuation, as well as what toexpect from the person conducting the valuation. This mightinclude educational information about the value andvaluation of intangibles, examples of what a valuation reportis expected to contain, information about the level ofknowledge required of IP valuators and information aboutwhat the profession has codified as its code of ethics.

Experts in the international Intellectual Asset Management arenahave laid three major arguments against standardization:

1. The number of factors that are specific to each intangiblemakes standardizing their valuations impossible.

2. Standardization could oversimplify what is inherently acomplex process.

The reasons for standardizing IPvaluations depend largely on the

perspective of the person asked. Peopleoutside the IP valuation community - forexample, regulators, tax authorities andaccounting standards setters - answer

differently from those inside it.

A R T I C L E S


3. We should avoid arriving at only one view of valuation - onethat is North American or European centric, for example.Such a singular view of IP valuation could cause people tomake assumptions about the value of IP that are notnecessarily valid in all corners of the world.

What can be standardized?Information material available suggests the following key factorsneed to be considered while arriving at a consensus fordevelopment of standard guidelines in ascertaining uniformpractices for establishing IP valuation.

1. Ethical guidelines for valuators: There are currently nogenerally agreed ethical standards to which valuators in theIP valuation community must adhere. There are individualprofessional groups within the IP community that havedeveloped standards of behaviour for their members, butthese are neither accepted nor necessarily practiced beyondthe borders of the groups’ membership lists.

2. Terminology: Too frequently, valuation reports contain termsand phrases that are undefined, ambiguous or unique to anindustry or area of business. A glossary or dictionary ofcommonly used terms would minimize misunderstandings.

3. The identification of elements that constitute the context ofthe valuation: It is now common wisdom in the IPmanagement community that IP (and other intangibles) areoperationally passive, having no value by themselves. It isonly when these intangible assets are teamed with other(often tangible) assets, operational capabilities or uses thattheir value can be realized. The context within which an IPasset is used defines the nature and amount of value it canprovide to a specific owner or user. Although ourunderstanding of context is still evolving, the panel providedan understanding of the elements that currently appear todefine it (Standards could require that the context of an IPvaluation be included in any valuation report).

4. The content of a valuation report: Clients often complain thatIP valuations are inconsistent. In part, this is true becausethere is no broad agreement on the appropriate or necessarycontent. An IP valuation standard could list appropriate anddesirable content categories with examples.

How should valuation standards be created and implementedsuccessfully? Several items are deemed to be particularlyimportant in developing IP valuation standards that are viewed ascredible by professionals within and outside the IP field. Theseare: oversight of the standards development process; broad-based professional participation; and an understanding of thesteps to be followed during the standards development process.

How to organize:- Although the large number of concernedstakeholders in this effort creates the possibility for an unwieldyorganization, the panel did not provide specifics on how theeffort might be organized. The panel agreed that a steeringgroup should guide the process, though it did not agree on itsmake-up. One view was that the steering group should compriseonly members of the IP valuation community, working closelywith a more widely constituted working group made up ofmembers of stakeholder organizations. The counterview wasthat the steering group should include both IP valuationcommunity members and other stakeholder representatives.

Summing up:- The valuation of intellectual property is morecomplex than valuation of real or tangible property. Numerousbusiness, academic, regulatory and professional bodies andindividuals have a stake in the valuation of IP. They view itthrough lenses that are polarized by the needs of their own

community. Developing any standard from the collectiveperspective of such a broad field of interested entities andindividuals will be difficult. One practical alternative appears tobe the potential development of IP valuation standards from theperspective of the IP valuation community, the group mostdirectly concerned with the quality and consistency of valuationresults. Other interested groups, individuals and organizationsmight adapt that standard to meet the needs of their owncommunities.

Although there are several conclusions one may draw from thepreceding discussion, two are unequivocal:

1. IP valuation standards would be useful, particularly if theywere focused on principles rather than on detailed rules.

2. At a minimum, such standards should focus on improvingboth the quality and the consistency of IP valuations andvaluation reports.

On the question of how such standards might be developed andimplemented, however, there is not yet a clear path. There is notyet an IP valuation profession, or even a common understandingof what or who constitutes the IP valuation community. Still, itappears that business and regulatory communities have a needand a desire for some sort of standard for valuation activity andperformance. Perhaps it is time to discuss whether to formalizean IP community (as distinct from the broader valuation andassessment community) as a step towards the ultimatedevelopment of an IP valuation profession.

Because there is no single organization capable of credibly andeffectively sponsoring an IP valuation standardization effort, aconsortium of several potential sponsoring bodies could becreated to provide the necessary oversight. Although today theIP valuation community is a community in name only, theimportance of IP valuations and the concomitant desirability ofan IP valuation profession mean that the development of an IPprofession should be a topic for future discussion.

As Vice President of the Institute of Cost & ManagementAccountants of Pakistan, and as member and advisor on theboard of the South Asian Federation of Accountants the authorstrongly recommends that the SAFA board should take up thisissue as a challenge and acclimatize member countries with thisvaluable subject.

Reference material from the works of:1. Dr. Daan Andriessen, Professor of Intellectual Capital at In Holland University

and author of Weightless Wealth2. Dr. Baruch Lev, Professor of Accounting and Finance at New York University;

author of two books and many articles on intangibles and their value 3 Rob McLean, President of Matrix Links, author of Re-Discovering

Measurement , and adviser to the Canadian accounting profession onintellectual capital and value measurement

4 Russell Parr, President of Intellectual Property Research Associates Inc(IPRA); author and co-author of 10 books on intangibles and valuation

5 Gordon Smith, Chairman AUS, Inc., author and co-author of several books onIP valuation; Adjunct Professor and director of IP Institute at Pierce Law

6 Dr. Alexander Wurzer, Managing Director of PATEV; Director of the Institute forIntellectual Property Management at Steinbeis University, and author ofseveral books and articles on IP valuation

Mohammed Hanif AjariVice President of the Institute of

Cost & Management Accountants of Pakistan and Director Strategic Development with

Getz Pharma (Pvt.) Limited

A R T I C L E S


Advanced Fee Fraud is a criminaloffence. The ‘scam’, as it is now widelyknown, is initiated by syndicates withmembers in different parts of the world

strategically located to implement theirdifferent tasks to ensure the success ofthe deals. As the name of the crimeimplies, the fraudsters through deceptionobtain money or goods from the victims inadvance in lure of promised financialbenefits accruable to the victims after theconclusion of the ‘deal’.

We should also note here that the dealsare usually not legal; there are alwaysindications of bribes to be paid to somegovernment or bank officials, evasion ofofficial tax and other illegal activities toensure the success of the deal. Whatusually attracts the victims to co-operatewith the fraudsters are the attractivefinancial benefits they hope to gain at theend of the deal, thus in the real senseboth the fraudsters and the victims havewrong motives.

The scam is initiated with the fraudstercontacting a targeted victim, either by fax,phone or e-mail and a proposal or request

made with the fraudster posing as seniorgovernment officials, a victim ordependant of government’s abuse ofhuman rights. They claim that they are in

possession of a largeamount of money.The proposal usuallyinvolves the transferof the money to abank account outsideof Nigeria, to that ofthe targeted victim. Aplausible orsympatheticexplanation is usuallygiven for the transfer,although theybasically appeal tothe intended victim’s

greed usually with a promise of a sizeablepercentage of the money transferred, as acommission for the use of the bankaccount.

If the intended victim is interested in thedeal, they are requested to forward avariety of paperwork which generallyincludes blank company letterheadswhich are duly signed, blank invoices,telephone and fax numbers, andespecially bank account details; thesebeing required to effect the transfer of themoney into the bank account.

F E AT U R E S O F T H E S C AML E T T E R S

� Urgency: The letter will stress theurgency of the matter.

� Confidentiality: The confidentialnature of the transaction is alwaysstressed.

� Forged Documents: Many forgedofficial-looking documents.

� Strong Ties: Claims are made that theother parties are employed in, or havestrong ties with the government, theCentral Bank of the country, ordependants of a dead or living victimof the government’s human rightsabuse.

� Huge Sums of Money: The dealalways involves the transfer of hugesums of money usually in dollarseither kept in a secret vault or accountknown only to the fraudster.

� No Risk: The victims are usually toldthat there is no risk involved.

� Bank Details: The bank details of thevictim are requested and somepersonal documents.

� Advance Fee: Finally an advance feeis usually required to either pay forsome legal fees, transfer fees, or tobribe government or bank officials.

The Internet has not only brought aboutdevelopment in communications andcommerce and all other facets of humanendeavors, but it has also provided aplatform for criminals to take advantageof unsuspecting members of the publicusing a faster and cheaper means ofcommunication. Unlike other criminalactivities, crime on the Internet has noboundaries. Hence, a scam letter canbe sent from any country to any part ofthe world, posing challenges to lawenforcement agencies all over theworld.

Advanced Fee FraudSaima Batool & Wasi Ahmed

A R T I C L E S


Sadia Kaleem, ACA

AUDIT FILEA. Please see that followings are in your

Audit Files:

1. Engagement letter 2. Evidence of audit planning 3. Audit program relating to the Profit

and Loss account items 4. Documentation of internal control

and risk assessment procedures.5. Extract of minutes of Board of

Directors meetings relating to FixedAssets.

6. Letter of representation 7. A copy of financial statements

approved by Board of Directors 8. Direct confirmations for finance

lease, trade debtors & tradecreditors.

9. Evidence in respect of advances,stock in trade and debtors.

10. Bank confirmation letters 11. Confirmation from tax advisor 12. Reconciliations of figures sent to

which party does not agree. 13. List of banks and legal advisors

from its client.14. Confirmation from legal advisors. 15. Disclosure checklist 16. Supervisor has initials on the

working papers.17. Going concern and Subsequent

review checklists are reviewed by asupervisor.

18. The basis of conclusion on whichthe auditor issued an emphasispara on going concern isdocumented.

19. Exceptions noted during audit areproperly disposed off.

20. Number of employees is disclosed.21. The amount of deferred tax is

provided and the related reasoning

22. Policy regarding staff retirementbenefits

23. Working papers reflect theconclusions drawn from the auditevidence.

24. Working papers are properlyreferenced or cross referenced

25. Verified existence of all motorvehicles & original documents

26. Certified & updated copy ofMemorandum and Articles is on thepermanent file.

27. Cash flow statement is signed bythe Board of Directors.

28. Sales and purchase cut off testsare applied by the auditors.

29. Contribution to Provident Fund bythe company

30. Management letter is sent by theauditors.

31. Evidence is documented in theworking papers indicating theweaknesses in the accounting andinternal control systems.

32. The letter of representation is dated.33. Disclosure requirements with

regards to the date of authorisationof financial statements

34. Tax deducted at source isseparately disclosed.

35. Note on the status of taxassessments is disclosed.

36. Work is performed by the auditorsto review any impairment of assets.

37. Working papers for :38. Provision for taxation39. Cash flow statement40. Statement of Changes in Equity41. Audit evidence exists for

comparison of cost and NetRealisable Value of stock in trade.

42. Stock in trade is distinguished asRaw Material, Finished Goods andWork in Progress.

43. Audit program for stock in trade andP&L items. Evidence of auditworking paper reference or anyconclusions drawn by auditor.

44. Work is performed for verification ofvaluation of stock based on lowerof cost or NRV and evidenced

45. Valuation sheets of stock in tradementions the rates at which thevaluation was made.

46. Physical count papers of stock intrade and stores are available.

47. The auditor attended the physicalstock count or an alternativeprocedures was carried out.

48. Information is provided of FinancialInstruments as per IAS 32.

49. The financial statements include thestatement of compliance with IAS asapplicable in Pakistan as required bypara 91a and 94 of IAS 1.

50. Corporate Governance Compliancereview checklist or evidence ofwork done in this respect.

51. Details of disposal of fixed assetsand names of persons to whomdisposals were made, is provided inthe financial statements.

52. Fraud and Error review checklist53. Sales and purchases were only

traced to the sales tax challans. Ona working paper, the auditorobserved that sales vouchers(supports) are not available.

54. Notes to the accounts are signedby the Board of Directors.

55. Sales tax payable is not mergedwith other liabilities.

A R T I C L E S


56. Audit ticks and work done isdocumented on working papers.

57. Audit evidence exists for creditors,other income, financial changes,and administrative and sellingexpenses.

58. Work to prove that auditorsperformed procedures to verifyexistence and valuation of stock.Working papers are not with an ex-partner who has left the firmbecause of dispute.

59. Surplus on revaluation of fixedassets is recorded properly.

60. An engagement letter is issued forfirst time audit.

61. Knowledge of the company or itsoperations is documented.

62. Preliminary judgement formateriality levels is considered.

63. Audit programs64. Evidence of review of work or

conclusions drawn.65. Letter of representation 66. Subsequent events review checklist

is available.67. Lease agreements 68. No work for Corporate Governance

compliance 69. Letter of representation is not signed

only by Chief Financial Officer. 70. Letter of representation was signed

five days before the date of theaudit report.

71. Letter of representation was signedby one director and was dated aday before the date of the auditreport.

72. Material variances in analyticalreview is recorded or discussed.

73. Last page of the notes to thefinancial statements of theapproved copy is signed by theChief Executive and Director.

74. Audit Report is dated before Letterof Representation.

75. Audit evidence is in file regardingstaff retirement gratuity, amountpayable to associated undertakings

76. Break down is available for long-term deposits..

77. Donations are disclosed separatelyas required by CompaniesOrdinance, 1984.

78. Audit sampling techniques areadopted even if extensive testingon random basis was performed

79. Unrecognised deferred tax liabilityis disclosed as required byCompanies Ordinance, 1984.

80. Current maturity of long termdeposits is disclosed as currentliability.

81. Auditors issued the Review Reportto the members on Statement ofCompliance with Practice of Codeof Corporate Governance.

82. Related parties are identified.83. Sufficient and adequate audit

evidence is available in respect ofCapital Work in Progress.

84. Auditor has documented thereasons for classifying Advanceagainst repurchase of landamounting to Rs. 25m outstandingfor three years as an advancerather than classifying it as a fixedasset.

85. The maximum amount outstandingas receivable at the end of anymonth during the year is disclosed.

86. Movement of accumulateddepreciation is disclosed asrequired by IS –16 Property, Plantand Equipment.

87. Depreciation methods used aredisclosed.

88. Depreciation is charged at revaluedamounts.

89. Auditor’s judgement on the changerate of depreciation is documentedin the working papers.

90. Sales tax payable and otherstatutory dues are disclosedseparately.

91. Movement in the provision fordoubtful debt balance is disclosed.

92. Note relating to transactions withassociated undertakings / relatedparties is disclosed.

93. Sufficient and appropriate auditevidence exists in respect ofDirector’s Loan account & directconfirmation is obtained.

94. Extracts of the minutes of the Boardof Directors meetings are in file.

95. Working for deferred taxation wasnot available in the working papers.

96. Letter of representation is dated. Itis on the company’s letterhead.

97. Note on status of pending /disputed tax assessments isdisclosed as required byCompanies Ordinance, 1984.

98. Advance tax deductions are shownas a separate line item rather thanunder receivables.

99. Some confirmation letters receivedfrom third parties were notspecifically addressed to the firm.

100. Letter of representation was dated18.07.03, whereas the audit reportwas signed on 09.10.03. It wassigned only by the GeneralManager Finance.

101. Auditor’s report is addressed to theshareholders of the company.

102. Evidence of physical verification ofshare certificates of short terminvestments

103. Advance to directors shown as partof Current Assets.

104. Subsequent events review wasperformed on 14.08.03, whereasaudit report was signed on 22.08.03.

105. Direct confirmations are received inrespect of Advances- Capital Workin Progress.

106. Sufficient and adequate auditevidence in respect of provision forslow moving and obsolete spares.

B. Please see that followingchecklist/details or workings are inAudit File:

1. Knowledge about client business 2. Directors meeting relating to Fixed

Assets. 3. Physical cash counts are done.4. Separate permanent file..5. Analytical review procedures at the

planning stage.6. Audit sampling techniques are

adopted while selecting items fortesting.

7. Audit report is in accordance withForm 35-A.

8. Preliminary judgement relating tomateriality level for audit purposesis considered.

9. Work is performed for valuation ofstock in trade.

10. EPS is disclosed in Profit & lossAccount.

11. Letter of representation is notsigned only by Chief Executive.

12. Unclaimed dividend is not disclosedas unpaid dividend.

13. The original copy of accounts is noton the auditor’s letterhead.

14. Balance Confirmations areaddressed to the firm, not to entity.

15. Working papers are reviewed. 16. Extent of verification performed is

documented in it.17. From banks if some securities are

not disclosed, reason must bedocumented.

18. Disclosure of future minimum leasepayments.

19. Procedures are performed toascertain the going concernassertion.

20. Working paper on going concernreview are developed and auditors’judgement regardingappropriateness of going concernassumption is documented

21. Following items are classified asrequired by the CompaniesOrdinance 1984: � Land - Freehold / Leasehold� Buildings - Freehold /

Leasehold22. Disclosure are made for

� Trade Debtors (consideredgood/ doubtful)

� Advances (considered good/doubtful ).

A R T I C L E S


2003 The Beginning of the EndIt all started in June 2003 when US Federal Reserve Chairman Alan Greenspanlowered the Fed’s key rate to 1%, the lowest in 45 years. In the same monththe US unemployment rate reached a then cyclical peak of 6.3% and heldthere until June 2004.

US monetary policy was intentionally eased between 2001 and 2004. TheFederal Reserve believed that monetary policy should respond aggressively topre-empt the threat of consumer price deflation. Monetary policy in Australia,Canada and much of Europe was also easy at this time.

However, according to Dr. Stephen Kirchner, a Research fellow at the Center forIndependent Studies, unintentionally this policy prompted the US governmentto subsidize financial risk-taking by home-buyers and financial institutions. Ashousing prices stopped rising and low introductory mortgage rates ended,buyers began defaulting on their loans. Many of the loans backed bonds thatwere sold to investors around the world.

By 2006 lenders had already made $640 billion in subprime loans. By thesummer of 2007, the first signs of the subprime crisis had started to appear. Bylate August of the same year defaults on subprime mortgages had started tooccur, much earlier in the mortgage process.

The signs of a weakening mortgage credit market were rapidly emerging.

PRELUDE


January 3, 2007

Ownit Mortgage Solutions Inc., whichowed Merrill Lynch around $93 million,files for Chapter 11 bankruptcy.

February 7, 2007

HSBC, London releases a statementabout a slump in its Mortgage Servicesoperations owing to increaseddelinquencies of US subprimemortgages. HSBC is Europe’s largestbank.

The bank is unable to refinance becauseof falling equity prices.

February 10, 2007

G7 Finance Ministers meet in Essen,Germany. On top of their agenda is thelack of regulation of hedge funds.

April 3, 2007

New Century Financial Corp. defaults on$8.4 billion in loan repayments and filesfor Chapter 11.

New Century had made $51.6 billion insubprime loans in 2006 making it the2nd largest subprime lender in the US.

Goldman Sachs, Morgan Stanley, andBank of America all backed NewCentury Financial Corp. whichoriginated more than $75 billion inhigh-cost loans between 2005 and2007.

May 2007

At the peak of the bull market in May2007, Royal Bank of Scotland teamed upwith Fortis and Santander to launch a€71 billion hostile bid for ABN Amro.The deal brought RBS to its knees andbecame a symbol of the credit crisis.Fred Goodwin, CEO of RBS, was blamedfor his role in leading the UK toeconomic disaster.

June 27, 2007

US Securities & Exchange CommissionChairman, Christopher Cox, testifies toCongress that the SEC has opened 12

enforcement investigations intocollateralized debt obligation (CDO)practices.

CDO is an investment-grade securitybacked by a pool of bonds, loans andother assets. CDOs are unique in thatthey represent different types of debtand credit risk often referred to as‘tranches’ or ‘slices’. Each slice has adifferent maturity and risk associatedwith it. The higher the risk, the morethe CDO pays.

July 9, 2007

Private equity firms* start raisingmoney to buy bad mortgage debt atdeeply discounted rates.

Credit Suisse releases a report statingCDO losses could total up to $52 billion.However, analysts say that did not poseany systematic risk to banks.

* Apollo, Blackstone, and TPG, Marathon AssetManagement, GSC Group, Pimco, and FortressInvestment Group are some of those active in themarket.

July 17, 2007

In a letter to investors, two Bear Stearnshedge funds specializing in subprimedebt announce that each fund has lostat least 90% of its value. The two fundshad $1.6 billion in investor capital.

Both funds had used ‘AAA’ ratedtranches of subprime, mortgage-backedsecurities.

Typically, hedge fund managers arecompensated with management fees of1-2% on assets and incentive fees of20% of all profits. This entices them toleverage more and more. During thecredit crisis they used this leverage tobuy more CDOs than they could pay forwith capital alone.

July 18, 2007

US Federal Reserve Chairman BenBernanke acknowledges that the Fedand other regulators had failed tocontrol aggressive mortgage lenders.

Bernanke estimates that the fallout fromthe US subprime crisis could be up to$100 billion.

July 24, 2007

Countrywide Financial, America’s biggestsubprime mortgage lender, says theproblems with subprime mortgageswere starting to spread to conventionalhome loans.

The company lost $704 million in 2007and another $893 million during thefirst quarter of 2008.

July 31, 2007

“The worst thing that ever happened toBear Stearns.”

The two Bear Sterns hedge funds thathad reported losses on July 17 file forChapter 15 bankruptcy. Bear Stearnswinds down the funds and liquidates allof their holdings.

August 1, 2007

Two civil lawsuits are filed against BearSterns for misleading investors aboutthe extent of exposure of the two hedgefunds to subprime debt.

August 3, 2007

The Germans get dragged in

A German government-led bailout of IKBDeutsche Industriebank results in state-owned KfW assuming up to €1 billion inlosses.

KfW and other banks agree to guaranteeup to €8.1 billion in liquidity to coverthe loss in value of Industriebank’ssubprime US investments.

August 9, 2007

… and then the French

BNP Paribas SA, France’s largest bank,freezes assets on three investment fundswith €1.6 billion in capital. The assetscould not be fairly valued due to theirexposure to the US subprime market.

In its biggest intervention in overnightrates since September 11, 2001, theEuropean Central Bank injects €95 billioninto the Eurozone banking system.

August 10, 2007

Central banks in Europe, Asia, and theAmericas inject $300 billion over 2 daysto prevent a credit market seizure.

The US Federal Reserve injects $38billion into the banking system, and theEuropean Central Bank injects over €150billion in an attempt to steady theEurozone credit markets.

August 16, 2007

Countrywide Financial Group loses morethan half its stock value and borrows$11.5 billion to avoid bankruptcy.

2007


Fitch drops Countrywide’s credit ratingto BBB+ and Moody’s to Baa3.

The Group announces 90% of new loanswould meet Fannie Mae and FreddieMac standards.

US mortgage lenders Fannie Mae andFreddie Mac were ‘governmentsponsored’ private companies set up tohelp segments of the mortgage marketrun smoothly.

August 24, 2007

In an attempt to restore investorconfidence Bank of America buys $2billion in preferred shares ofCountrywide Financial.

August 26, 2007

Sachsen Landesbank emerges as thesecond German bank needing a bailout.

German public sector bank LandesbankBaden-Württemberg (LBBW) agrees tobuy Sachsen for €250 million.

September 14, 2007

Rumors about a larger bank purchasinggiant British mortgage lender NorthernRock are afloat.

The Bank of England extends emergencyfunding to Northern Rock after investorswithdraw their support.

September 15, 2007

Lehman Brothers collapses in theworld’s biggest bankruptcy.

As banks around the world struggle toissue debt, several emergency rescuemergers are struck. Bank of Americaspends $44.4 billion on Merrill Lynch. Inthe UK, Lloyds TSB takes over HBOS for$21.9 billion, and the Britishgovernment takes over 70% control ofRBS.

September 26, 2007

In its attempt to inject liquidity in to thebanking system the Bank of Englandannounces an auction of £10 billion ofemergency three-month funds at 6.75%and agrees to accept bank mortgages ascollateral.

No bids are received.

October 1, 2007

Swiss bank UBS announces a $3.7 billionwritedown.

October 16, 2007

Owing to writedowns linked to subprimemortgages, Citigroup’s profits drop 57%from the same quarter in 2006.

Around the same time in October recordlevels of foreclosures are expected inthe US with $350 billion in adjustable-rate mortgages (ARMs) in themarketplace. A worldwide freeze incredit market activities is evident.

Approximately 80% of U.S. mortgagesissued to subprime borrowers wereadjustable-rate mortgages. ARM is atype of mortgage in which the interestrate paid by the borrower is based on abenchmark plus an additional spread.

October 25, 2007

Merrill Lynch announces a $2.24 billionthird quarter loss.

Merrill Lynch has written down $7.9billion on CDOs and subprimemortgages, the largest writedown in thecredit crisis so far.

On October 31, Merrill Lynch CEO StanO’Neal resigns with a severancepackage of $160 million.

October 26, 2007

Countrywide Financial announces a $1.2billion third quarter loss, its first loss in25 years.

Countrywide has written down about$1 billion.

November 12, 2007

Three major US banks, Citigroup, Bankof America, and JP Morgan Chase, agreeto buy $75 billion in weak debt aspurchaser of last resort.

Citigroup is the largest bank in the US.

November 13, 2007

Bank of America says it will have towriteoff $3 billion in bad debt. The bankalso says it will spend $600 millionsupporting some of its funds because ofpossible liquidity problems.

November 15, 2007

Barclays confirms a $1.6 billionwritedown on their subprime holdingsand warns of more writedowns.

November 21, 2007

Freddie Mac announces a $2 billion lossin mortgage defaults and credit losses.

Following this announcement, shares inFreddie Mac and Fannie Mae drop28.7% and 24.8% respectively.

November 23, 2007

Two French banks pledge $1.5 billion tobailout French bond insurer CIFG, on theverge of losing its AAA rating.

November 27, 2007

The Abu Dhabi Investment Authoritypurchases $7.5 billion worth ofconvertible securities with an 11%coupon from Citigroup.

Freddie Mac announces a $6 billionshare issue to cover more losses frommortgages.

German state-owned KfW doubles itsbalance sheet risk provisions from theirbailout of IKB to €4.8 billion in expectedlosses.

KfW says IKB’s subprime portfolio hadsignificantly deteriorated since thebailout in August. KfW had initiallyassumed €1 billion in losses from itsbailout of IKB.

November 29, 2007

Slowdown in UK housing market

Bank of England releases data showingmortgage approvals have fallen to theirlowest level since 2005.

Slowdown begins in the UK housingmarket. UK housing prices have fallen by0.8% in November, the largest drop in12 years.

United States lowers its growth forecastfor 2008 from 3.1% to 2.7% owing to thehousing and credit markets declinecombined with high oil prices.

Total job cuts at Bear Stearns come toaround 1500 which is more than 10% ofits workforce.

December 3, 2007

Moody’s announces ratings cut on debtof up to $116 billion.

Much of this debt was on account ofstructured investment vehicles (SIVs)that relied heavily on the subprimemarket.

December 6, 2007

George W. Bush announces plans tohelp homeowners in trouble by freezing

interest rates on subprime loans for fiveyears.

Royal Bank of Scotland (RBS) announcesit expects to write down £1.25 billiondue to exposure to the US subprimemarket.

December 10, 2007

UBS announces $10 billion more inwritedowns associated with theirsubprime holdings and a capitalinjection of $11.5 billion from theSingapore government and an unnamedMiddle East investor.

December 12, 2007

In order to provide more liquidity to thecredit markets, the US Federal Reservecreates a Term Auction Facility (TAF)designed to allow banks to get Fedfunds by pledging all sorts of collateral.TAF is open to all depository institutions believed to be financiallysound.

The Federal Open Market Committeealso approves swap agreements toprovide $20 billion to the EuropeanCentral Bank and $4 billion to the SwissNational Bank.

Swap agreements are reciprocalcurrency arrangements approved for upto six months.

December 18, 2007

The European Central Bank allocates$502 billion to banks at a below marketinterest rate to cut the cost of lendingbetween commercial and retail banks.

The ECB was one of five central banks toinject liquidity into the market.

December 19, 2007

Morgan Stanley announces $9.4 billionin writedowns from subprime losses andreceives a capital injection of $5 billionfrom a Chinese sovereign wealth fund tocover them.

December 20, 2007

For the first time in its 84 year historyBear Stearns reports a quarterly loss of$854 million with a fourth quarterwritedown of $1.9 billion on itsmortgage holdings.

CEO Jimmy Cayne and other topexecutives do not receive a bonus for2007. This makes headline news.

December 21, 2007

After a run on assets, Friends Provident,a UK commercial property fund with£1.2 billion, freezes withdrawals andtells investors it could take up to sixmonths to get their money out.

This is the first property fund to freezewithdrawals since the last UK propertycrash 15 years ago.

January 8, 2008

Jimmy Cayne retires as CEO of BearStearns and President Alan Schwartztakes over as CEO.

January 9, 2008

World Bank releases its Global EconomicProspects study forecasting worldwideeconomic growth at 3.3% in 2008. Thestudy says strong growth in emergingmarkets will help to turn around theeffects of the global credit crisis.

MBIA, the world’s largest bond insurer,slashes its dividend by more than 60%and announces plans to raise $1 billionin debt to raise liquidity.

Monoline insurers such as MBIA andAMBAC write a single type of insurancecontract, usually for bonds or asset-backed securities. Since these insurershave AAA debt ratings, the bonds alsohave a AAA debt rating, regardless ofthe financial health of the borrower.

January 11, 2008

Merrill Lynch and Citigroup announceplans to seek additional capital fromsovereign wealth funds.

Citi looks to go back to the Abu DhabiInvestment Authority while Merrill eyesthe Kuwait Investment Authority.

January 15, 2008

Citigroup reports a $9.83 billion loss inthe fourth quarter resulting from an$18.1 billion writedown on its subprimemortgage-related exposure.

Citi also announces it would raise $12.5billion in new capital to shore up its

balance sheet; $6.88 billion of which willcome from the Government ofSingapore Investment Corporation.

January 16, 2008

JP Morgan Chase says it has cut itsinvestments in the US subprime marketby $1.3 billion.

Wells Fargo reports a 37% loss in netincome for its fourth quarter.

January 17, 2008

Lehman Brothers announces plans tocut another 1,300 jobs in its domesticmortgage division in addition to the2,500 lost already.

Moody’s Investor Services hints largebond insurers could lose their AAAratings.

The two largest bond insurers Ambacand MBIA fall 52% and 31% respectively.

Ambac is the world’s second largestmonoline insurer.

Merrill Lynch reveals a net loss of $7.8billion for 2007 compared to a $7.5billion net profit in 2006.

Merrill’s had a $14.1 billion writedownon investments related to subprimemortgages.

January 18, 2008

After a run on assets, Scottish Aegonbecomes the second property fundforced to freeze withdrawals andannounce investors may have to wait upto a year to get their money back.

January 19, 2008

Fitch downgrades Ambac from AAA toAA.

A ratings downgrade could mean billionsof dollars in writedowns on Ambacguaranteed securities and force banks tocough up more capital to cover theincreased risks.

January 21, 2008

Ambac’s downgrade has hugeimplications

As a result global stock markets inLondon and Europe suffer the biggestone day loss since September 11, 2001.

FTSE 100 index falls 5.5% wiping out £76billion in market value as investors sell


2008

off equity for the safety of governmentbonds.

Troubled bond insurer ACA Capital facescollapse if it can not come up with atleast $1.7 billion to pay policy claims.

ACA had written insurance on $69billion in corporate and mortgage debtsecurities but announced that its claimspaying base was only about $425 million.

ACA’s trading partners, including someof the world’s largest banks, hadentered in to a ‘forbearanceagreement’ to waive all collateralrequirements, policy claims, andtermination rights until February 19.

January 22, 2008

Panic sets in global credit markets

The US Federal Reserve cuts interestrates by 75 basis points which is thelargest cut in over two decades.

Owing to $5.21 billion in writedowns onsubprime mortgage guarantees AmbacFinancial reports a record loss of $3.26billion.

January 24, 2008

The United States Congress agrees on a$150 billion economic stimulus packageto save the US economy from slippinginto recession.

The package includes tax refunds of$300 to $1,200 to over 117 millionAmerican families.

Congress also raises the mortgagepurchase limit for Fannie Mae andFreddie Mac from $417,000 to$625,000.

January 26, 2008

Financial Times announces that Bank ofAmerica (BofA) and Countrywide are inmerger talks to create the largestmortgage lending group in the US.

Analysts say the acquisition ofCountrywide could cost BofA $30billion in addition to the $2 billion itinvested in Countrywide’s preferredshares in August, 2007.

January 29, 2008

In a joint investigation of accountingfraud and insider trading, the USSecurities & Exchange Commission andthe Federal Bureau of Investigation (FBI)crack down on fourteen lenders andinvestment banks.

January 30, 2008

Role of credit rating agencies comes into question

European leaders meet in London for acredit crunch summit. They ask creditrating agencies and big audit firms tohelp restore confidence in financialmarkets.

Credit ratings are widely used in Basel IIcapital requirements and in assessmentof acceptable collateral in liquidityoperations by central banks.

February 3, 2008

The auction-rate security market startsfaltering as dealers stop taking unsoldsecurities in auctions.

Financial regulators from the world’sleading economies meet in Amsterdamto discuss markets’ dependence oncredit ratings.

G-7 finance ministers agree on a moreuniversal enforcement of Basel II

February 7, 2008

Regulatory pressure builds up on theagencies

In response to regulatory pressureStandard & Poor’s releases a reformplan focusing on four main areas:governance reforms to address conflictsof interest; examining the accuracy ofcredit ratings; increased ratingstransparency; and more information toinvestors.

February 8, 2008

Deutsche Bank reports profits of $9.4billion for 2007.

CEO Josef Ackermann says he did notexpect any more writedowns fromsubprime portfolios, after the thirdquarter €2.2 billion including leveragedloans, but says the bank still hadexposure to leveraged loans.

February 11, 2008

G-7 Finance Ministers meet in Tokyo todetermine that write-off losses on USsubprime mortgages could reach up to$400 billion. The ministers ask banks toprovide full disclosure on the losses.

February 12, 2008

Billionaire Warren Buffett offers to takemore than $800 billion of municipalbonds backed by three monolines:

Ambac, MBIA, and Financial GuaranteeInsurance Company (FGIC).

This is in response to a possible creditrating downgrade of the monolinesthat insure the bonds. Ambac declinesthe offer.

Credit Suisse announces its writedownson subprime mortgage exposure totaled2 billion Swiss francs for 2007.

February 13, 2008

Data from Japanese financial watchdog,Financial Services Agency (FSA), showsJapanese subprime writedowns reached$5.6 billion in 2007.

February 14, 2008

Commerzbank, Germany’s secondlargest bank, announces record profits in2007 despite $1.1 billion in subprimewritedowns.

Swiss bank UBS confirms a $4 billion lossin 2007 on $18.4 billion in subprimewritedowns as well as $26.6 billion inexposure to risky mortgages.

February 15, 2008

Moody’s pulls its AAA rating fromFinancial Guarantee Insurance Company.

February 17, 2008

Nationalization of Northern Rock

British government takes over thebeleaguered Northern Rock, UK’s fifthlargest mortgage lender, after twoprivate sector bids fail —- one fromNorthern Rock’s management, the otherfrom Richard Branson’s Virginconsortium.

UK Chancellor of the Exchequer AlistairDarling says the two private offers tobuy out the bank are insufficient toensure pay back of loans.

Northern Rock owed the Bank ofEngland £25 billion in loans after a runon the bank in September 2007.

The inter-bank lending market was themain source for Northern Rock’sliquidity before the US subprimemortgage fallout which deterioratedcredit conditions and investorconfidence.

February 18, 2008

Loans given by the US Federal Reservethrough the Term Auction Facility reach$50 billion in one-month funds raising


fears that the collateral given for theseloans was increasing the Fed’s exposureto the credit crisis.

The Fed views Term Auction Facility asa means to channel liquidity instead ofthe discount window which couldtrigger investor concern.

February 23, 2008

Citigroup, Wachovia, Barclays, RoyalBank of Scotland, Societe Generale, BNPParibas, UBS, and Dresdner are in talksto inject $2 to $3 billion in Ambac toavoid a ratings downgrade.

The European Commission and theInternational Monetary fund prepare tointroduce voluntary guidelines forgovernance and transparency insovereign wealth funds (SWFs).

Several SWFs invested heavily in banksduring the credit crisis raising fears theirmotivations were more strategic thancommercial.*

* According to IMF estimates, stateowned funds control about $1,900 to$2,900 billion in global funds.

February 28, 2008

AIG announces a $5.2 billion fourthquarter loss in 2007, its secondconsecutive quarter of losses.

Most of these losses are a result ofAIG’s $11.12 billion (pretax) inwritedowns. AIG has written $78 billionin credit default swaps (CDS). CDS islike an insurance contract where acompany promises to cover certainsecurities in the event of default.

March 3, 2008

HSBC reports a $17.2 billion loss onwritedowns of its US mortgage portfolio.

March 5, 2008

France’s largest retail bank, CreditAgricole, announces a €857 million lossafter writedowns of €3.3 billion on itsexposure to the credit crisis. The loss ismuch worse than Agricole’s forecast inDecember 2007.

March 10, 2008

Bear Stearns stocks drop amid rumors ofliquidity problems.

Lehman Brothers cuts 5% of itsworkforce across all lines of business.Total job loss at Lehman comes to 5,425employees.

In response to its AAA downgrading byMoody’s and S&P, Ambac announcesplans to issue $1.25 billion in newshares and $250 million in equity-linkedinstruments. A consortium of largebanks will purchase most of theseshares.

FGIC sues German bank IKB on chargesof providing misleading information thatexposed FGIC to $1.9 billion in liabilitiesand a ratings downgrade.

March 11, 2008

The Federal Reserve offers primarydealers up to $200 billion in treasurysecurities for 28 days in return for AAArated private mortgage backed securities(MBSs) as collateral.

The loans are implemented through anew Term Securities Lending Facility forinvestment banks.

As on February 18, 2008 the moveunderscores that the collateral wouldincrease the Fed’s exposure to the creditcrisis; defaults on the MBS wouldultimately be borne by taxpayers.

March 12, 2008

In an interview with CNBC, Bear StearnsCEO Alan Schwartz denies rumors aboutthe hedge fund’s liquidity position andblames stock variability of the last fewdays on market speculation.

March 13, 2008

Bear Stearns reports a $2 billion drop inliquid assets among rumors of illiquidity,reflecting a loss of $15 billion in cashand cash equivalents in two days.

A $22 billion mortgage-backed hedgefund run by Carlyle Capital Corporationcollapses. Remaining assets would betaken up by banks for repayment ofdebts. The fund was slightly leveragedwith $31 in debt per every $1 in equity.

March 14, 2008

Bear Stearns and JP Morgan Chasediscuss permanent financing agreement.Bear Stearns shares trade at $30.

March 16, 2008

The collapse of Bear Stearns, once oneof the biggest investment banks onWall Street.

JP Morgan Chase announces it willacquire Bear Stearns for $2 per share, a

fraction of what the bank was onceworth.

To avoid a fire sale the Federal ReserveBank agrees to fund up to $30 billion ofBear’s long-term assets.

The Bear Stearns collapse raisesconcerns about the instability of thecredit default swap market. In mid-2007, the CDS market was worth $45trillion, more than twice the size of theUS stock market. Commercial bankswere most active in the CDS marketwith the top 25 banks holding morethan $13 trillion.

March 17, 2008

UBS reduces its balance sheet by $520billion after adjusting the Bear Stearnssale price.

March 18, 2008

Lehman Brothers and Goldman Sachsannounce profits for the first quarterbetter than what analysts had expected.

March 24, 2008

Morgan Chase raises its price on BearStearns to $10 per share after theoriginal merger at $2 per share fallsthrough because of opposition by BearStearns shareholders.

March 26, 2008

It transpires that of all the Asian banksthe Bank of China has the largestexposure to subprime mortgages. TheBank announces increased growth insecuritization holdings despite a $1.3billion writedown.

March 27, 2008

Moody’s announces it would hold backratings unless mortgage lendersprovided more transparent borrowerinformation such as borrower income,employment and occupancy, andproperty value.

UK Financial Services Authority releasesan internal report highlighting oversightfailures of Northern Rock. FSAannounces beefing up capacity tooversee the complex financial modelsbanks use to assess risk.

The main errors highlighted in thereport were: extraordinarily highturnover of FSA staff directlysupervising Northern Rock; inadequatenumbers of staff assigned to NorthernRock; and very limited direct contactwith Rock executives.


March 31, 2008

US Treasury Secretary Henry Paulsonannounces a blueprint on a long termregulatory model with a three tierregulatory framework:

One focused on market stability acrossthe entire financial sector ; one focusedon safety and soundness of institutionssupported by a federal guarantee; andone focused on protecting consumersand investors.

Gordon Brown and George W. Bushannounce plans to establish a UK-USworking group to enhance cooperationbetween US and UK regulators.

A month after being nationalizedNorthern Rock announces plans to repay£23 billion in loans to the Bank ofEngland by laying off one-third of itsstaff, halving its balance sheet, andshedding 60% of its mortgage holders.

April 1, 2008

Banks improve balance sheets byselling off leveraged loans and riddingthemselves off mortgage backedsecurities

UBS announces a $19 billion firstquarter writedown on its US holdings,and a rights offering of $13.1 billion tohelp offset the writedown.

UBS shares fell 83% in 2007 following$18 billion in writedowns.

Deutsche Bank announces a $3.9 billionfirst quarter writedown linked to itsleveraged loan portfolio which includingexposure to commercial real estate, halfof it in the United States.

April 2, 2008

EU proposes changes to Basel II capitalrequirements including rules to limit therisk stemming from large bankexposures, harmonization of definitionsof hybrid capital, capital requirementsfor default risks in banks’ trading books,and technical changes to thesecuritization framework.

Bank for International Settlementsreleases a report saying complex debtsecurities used to repackage asset-backed bonds will likely disappear as aresult of the credit crisis.

The report further says that issuances ofcollateralized debt obligations of asset-backed securities (ABS) had been

running at $70-$100 billion a quarterfrom 2005 to 2007.

The securities backing ABS are assetssuch as auto loans, leases, credit carddebt, a company’s receivables, royaltiesand so on, and not mortgage-basedsecurities.

Morgan Stanley releases a report sayinginvestment banking revenues would fall20% in 2008 excluding the expected $75billion in further writedowns.

April 7, 2008

The Concise Oxford English Dictionaryadds ‘subprime’ and ‘credit crunch’ tothe new words included in its nextedition.

Credit crunch is defined as ‘a severeshortage of money or credit’.

Subprime is defined as ‘a credit or loanarrangement for borrowers with a poorcredit history, typically havingunfavourable conditions such as highinterest rates’.

April 8, 2008

The International Monetary Fundreleases its Global Stability Report whichprojects the new estimate on creditcrunch losses upwards of $945 billion.

The Financial Times reports thatCitigroup is in negotiations with privateequity firms to sell $12 billion in loans toshrink its balance sheet and exposure tothe subprime crisis.

April 9, 2008

Washington Mutual, the largest savingsand loans bank in the US, announces itwill raise $7 billion from outsideinvestors to cover losses arising from itssubprime mortgages.

The investors are led by private equitygroup, TPG, which will provide $2billion. The investment will come in theform of an additional 176 million ofnew shares of stock.

April 11, 2008

The Council for Mortgage Lenders (CML)warns that mortgage lending in the UKcould go down by 50% if fresh liquidityis not injected into the market.

April 14, 2008

Wachovia announces plans to raise $7billion in capital after reporting a firstquarter loss of $393 million.

The $7 billion would come from anoffering of common stock andconvertible preferred shares. Wachoviaalso announces a dividend slash of 41%and 500 job cuts.

April 17, 2008

Merrill Lynch reveals first quarter lossesof $1.96 billion compared to a $2.1billion profit in 2007. The bank says itplans to cut 4,000 jobs worldwide.

Merrill’s writedowns from subprimemortgages in first quarter of 2008amount to $4.5 billion, added to $24billion in writedowns from 2007.

April 18, 2008

Citigroup, the largest US bank, reports afirst quarter $5.11 billion loss off a $12billion write down on subprime loans.The bank announces another 9,000 jobcuts.

April 22, 2008

In a move to unblock interbank lendingBank of England offers to acquire UKbanks’ mortgage-backed securities forup to three years in return for treasurybills.

Royal Bank of Scotland announces adeeply discounted £12 billion rightsissue in attempt to raise capital to cover£5.9 billion in writedowns on its April-June investments.

The rights issue is the largest in UKcorporate history and the writedownsare the largest yet for a British bank.

April 23, 2008

In the US writedowns across thefinancial system from subprime relatedassets exceed $200 billion and are set torise.

Big US financial groups raise more than$28 billion in capital markets. The 20largest US banks have raised in excessof $80 billion in capital since October2007.

US Securities & Exchange Commissiondraws up rules to govern credit ratingagencies.

Wall Street bankers say the worst of thecrisis is over.

April 24, 2008

With $5 billion in US leveraged loans,Deutsche Bank prepares anothermultibillion dollar sale making it the


third big sale in April after Citi led theway with a $12 billion sale.

Banks are trying to sell a backlog ofabout $100 billion in leveraged loansthey’re holding.

May 1, 2008

Credit markets are deteriorating fast.Increasing cost of credit is making itdifficult to do business. US home pricesdrop 15.8%.

Citigroup raises $4.5 billion in equityoffering. The Article lists capital raisings.

May 6, 2008

Swiss Reinsurance Co., the world’sbiggest reinsurer, announceswritedowns of $782 million whilerestructuring credit default swaps.

UBS sells $15 billion of subprimemortgage debt to US asset managerBlackRock at a 25% discount from itsface value of $20 billion.

BlackRock, 49.8% owned by MerrillLynch, manages about $1,360 billion inassets including $29 billion from theBear Stearns bailout.

The deal signifies that private investorsare willing to place bets on subprimedebt to gain when the market turnsaround. These investors are bettingthat the valuation techniques arevaluing the debt below what it isworth.

May 9, 2008

Owing to a writedown of $9.11 billionon the revaluation of its credit defaultswap portfolio, AIG reports first quarternet loss of $7.81 billion. AIG HoldingCompany is downgraded to AA-.

AIG also announces it will raise $12.5billion in capital through a stock offeringto generate liquidity.

May 12, 2008

HSBC reports $3.2 billion in subprimewriteoffs in the first three months of2008.

HSBC now ranks fourth among big bankswith total writedowns behind Citibank,UBS, and Merrill Lynch.

May 13, 2008

The Financial Times releases a table ofwritedowns showing worldwide bankwriteoff totaling almost $450 billionsince January 2007.

The table breaks down the total foreach of the world’s major banks.

MBIA announces a $2.4 billion loss as aresult of write downs on CDS, more thantwice that of analyst estimates. MBIAstock lost more than 80% of its value in2007.

May 14, 2008

Freddie and Fannie: “thinly capitalized,highly leveraged, and a systemic risk totaxpayers”

Freddie Mac announces it will raise $5.5billion in capital.

In its first offer to help Freddie Mac andFannie Mae the US Office of FederalHousing Enterprise Oversight lowerssurcharges on Freddie Mac’s regulatorycapital requirements. Freddie Mac’sshares rise 9% with the announcement.

A report by Fitch Ratings says bankshave written off 80% of their subprimelosses. The report estimates total losseson subprime mortgages and CDOs couldreach $400 billion.

May 15, 2008

Barclays UK announces a £1 billioncredit writedown and confirms its firstquarter profits would be lower than in2007.

May 21, 2008

A Financial Times investigation uncoversthat owing to a computer coding error,Moody’s had awarded an incorrect AAArating to billions of dollars of complexdebt products.

Top Moody executives were aware ofthe problem in early 2007 but didnothing until January 2008.

The glitch was significant because mosthigh powered investors require 2 AAAratings before investing and Moody’sprovided the second rating afterStandard and Poor’s.

Moody’s Investors Service downgradesFrench bond insurer CIFG from A1 toBa2 due to its increased writedowns on

CDOs backed by risky mortgages. Thisdowngrade could put CIFG in violationof its regulatory capital requirements,potentially leading to insolvency.

May 22, 2008

Following investigation, Moody’sdeclares that faulty computer modelshad incorrectly rated up to $4 billion ofcomplex debt products as AAA. Moody’sstock price falls 16%.

The Institute of International Finance*proposes that banks that have notwritten off their bad debts be allowed to:use historical rather than market prices;andsell assets after two years instead ofholding until maturity.

FASB and IASB do not support thisproposal saying it would be dangerousto change the rules at a time whentransparency was imperative.

The Financial Services Authority, UKannounces it will factor in banker paystructures when considering overall riskto a financial institution.

The Basel II Accord enables regulatorsto impose additional capital charges forincentive structures that promote riskybehavior.

To cover $19 billion in first quarterwritedowns UBS offers stockholdersdeeply discounted rights issue to raise$15.5 billion.

* The Institute of International Finance is an alliance of

300-plus companies including banks.

May 25, 2008

The International Accounting StandardsBoard invites bankers and regulators toform a new working group to look in tothe problems of valuing securities in anilliquid market.

The current model of ‘fair value’accounting has caused banks to write offmore than $300 billion in bad debt.Critics of fair value believe the debt willbe written back up when marketsrebound and this swing is contributingto the lack of confidence in financialmarkets.

May 29, 2008

After a final price of $10 per share JPMorgan Chase completes its acquisitionof Bear Stearns.


June 6, 2008

The credit crisis has exposed overreliance on credit ratings for evaluatingsecurities. Rating agencies publishedhigher ratings for complex financialproducts.

Standard & Poor’s downgrades MBIAand Ambac, the two largest bondinsurers, from AAA to AA owing tofurther deterioration of US mortgagemarkets and the CDOs insured by themonolines.

This downgrade could cause furtherwritedowns of up to $10 billion forbanks like Citigroup, Merrill Lynch andUBS with the most exposure to thesemonolines.

US Federal Reserve approves Bank ofAmerica takeover of CountrywideFinancial.

June 13, 2008

Following an inquiry by the SEC,Standard & Poor’s also announces errorsin rating models, but says the glitch didnot affect the ratings of the debt.

June 16, 2008

US SEC announces plans to overhaulregulation governing credit ratingagencies by disallowing them to rate thesecurities that they help design, andincreasing disclosure requirements forthese agencies such as requiring themto flag complex securities which couldbe risky for investors.

Incidentally, the SEC itself relies oncredit ratings with explicit references toratings in its market rules whichassume that securities with high creditratings are liquid and have lower pricevolatility.

Lehman Brothers reports a $2.8 billionsecond quarter loss. President JoeGregory and CFO Erin Callan resign.

June 19, 2008

For the love of money!

In the first criminal charges broughtabout in the credit crisis, Ralph Ciofi andMatthew Tannin, two former BearStearns hedge fund managers, arearrested for securities fraud and insidertrading. The two funds had collapsed inJuly 2007.

The US Federal Bureau of Investigation(FBI) cracks down with its ‘Operation Malicious Mortgage’ on anyone involved

in suspect mortgage practices thatcaused roughly $1 billion in losses.The Operation yields 406 defendantsin144 cases.

June 25, 2008

Barclays announces a £4.5 billion sharesissue to boost its capital ratios which aresome of the lowest in Europe. QatarInvestment Authority, an SWF, andchairman of Qatar Holding finance halfof the offering.

Countrywide shareholders vote toapprove the attempted takeover byBank of America.

July 1, 2008

A government bailout of Freddie Macand Fannie Mae is imminent. Federalresearchers say the bailout could costAmerican taxpayers up to $25 billion.July turns out to be the worst monthfor mortgage-backed bonds since thebeginning of the subprime crisis.

UK Treasury announces new guaranteescheme raising deposits covered from£35,000 to £50,000 hoping to preventany runs on the banks.

July 4, 2008

US private equity group TPG pulls out ofa deal to invest £179 million in UKmortgage lender Bradford & Bingleyafter Moody’s accords B&B one of thelowest ratings of any of the largeEuropean banks.

July 8, 2008

Shares in Fannie Mae and Freddie Macplunge around 20% as investors sell offtheir shares after a Lehman Brothersreport that accounting changesproposed by the FASB could forceFreddie and Fannie to bring securitizedmortgages back onto their balancesheets resulting in a total of $75 billionin regulatory capital charges.

July 10, 2008

Barrat Developments, one of the UK’slargest house builders, warns job cuts inthe house building sector could reach60,000 of the 300,000 employeesemployed directly or indirectly.

July 12, 2008

US bank IndyMac, with assets of $32billion, closes down after being unableto meet withdrawal demands bycustomers.The bank’s rescue isestimated to cost between $4 and $8billion.

The bank’s main regulator is the USOffice of Thrift Supervision which failedto recognize IndyMac’s risky lendingpractices.

July 13, 2008

US Treasury concedes a large injectionof public funds to save Freddie Mac andFannie Mae from insolvency.

Investors, including large hedge funds,employ the take-under strategy in thebelief that the government will bailthem out to protect the financialmarket.

Take-under strategy means to short sellthe stock causing share price to fallfurther, and then investing theproceeds in the company’s debt.

July 14, 2008

US Treasury Secretary Henry Paulsonoutlines a three point plan to saveFreddie Mac and Fannie Mae:

i) the Treasury will be authorized to increase the current $2.25 billion lines of credit to Freddie and Fannie;

ii) the Treasury will have the power to purchase equity in the companies if necessary; and

iii)the entities will have access to borrowing from the Fed’s discount window.

July 16, 2008

Wells Fargo, the fifth largest US bank,reports better than expected secondquarter earnings with $1.51 billion inwriteoffs and a 10% increase individends.

Martinsa-Fadesa, one of Spain’s largestproperty companies, files for bankruptcyafter failing to raise equity to complete a€4 billion debt refinancing with banks.

La Caixa, the largest Spanish bank,announces a €700 million loanexposure.

July 17, 2008

Richard Holbrooke, a director at theAmerican International Group (AIG),resigns after two straight quarters offinancial losses.

Merrill Lynch announces writedowns of$9.4 billion primarily on its mortgagerelated assets and hedges with troubledbond insurers.

Merrill has posted a loss of almost $19billion in the last four quarters. Merrill


also announces a selloff of $8 billion inassets to raise much needed capital.

JP Morgan Chase posts a net income of$2 billion despite $2.4 billion inwritedowns in the second quarter of2008.

Goldman Sachs announces earnings of$2.1 billion.

July 19, 2008

Citigroup announces losses of $2.5billion after second quarter write downsof $7.2 billion in bad debt.

This is significantly better than the $3.67billion in losses predicted by analysts.Citigroup shares jump 7.7% on thenews.

July 21, 2008

Bank of America (BofA) announcesbetter than expected second quarterearnings of 72 cents a share withwriteoffs totaling $3.6 billion.

July 22, 2008

US Congressional Budget Office says theUS Treasury would have to cover $100billion in losses if the mortgage marketkeeps getting worse. US mortgage ratesreach their highest levels in a year.

Wachovia declares an $8.9 billion dollarsecond quarter loss, the largest in thecompany’s history.

July 23, 2008

US House of Representatives passes arescue plan for Freddie Mac and FannieMae allowing the government toguarantee up to $300 billion inmortgages refinanced through theFederal Housing Administration.

The Basel Committee on BankingSupervision proposes incremental riskcharge (IRC) which would make it morecostly for banks to hold structured debtproducts that helped exacerbate thecredit crisis.

IRC would also apply to investmentbanks.

July 24, 2008

New York State Attorney GeneralAndrew Cuomo files charges against UBSexecutives for selling more than $21million of their personal holdings ofauction-rate securities and falselymarketing them as safe and liquid.

July 29, 2008

Trade partners of SCA, an insolventbond insurer, agree to drop their claimsin exchange for cash to allow themonoline to avoid being taken over bythe US insurance regulator. The tradepartners include Merrill Lynch and 13other banks.

July 30, 2008

US SEC extends its ban on ‘naked short-selling’ on Fannie Mae, Freddie Mac and17 large bank stocks.

Naked short- selling allowed investorsto bet on a stock falling without havingto pay interest leading to increasedspeculation.

July 31, 2008

Deutsche Bank reveals total writedownsof $7.8 billion for 2008. Without figuringin the write downs Deutsche would havean income 16% less than the secondquarter of 2007.

The European Commission outlines aplan to subject credit rating agencies toa single supervisory regime in order tooperate in Europe.

In an 80 page complaint Massachusetts’Secretary of State, William Galvin,accuses Merrill Lynch of fraud in theirselling techniques of auction-ratesecurities (ARS) by avoiding towarninvestors of the risks of ARS.

ARS are long-term debts issued bymunicipalities and others whoseinterest rates are set at bank-backedauctions.

August 4, 2008

The credit crisis extends to Asia

HSBC, UK cautions that the credit crisisis starting to leak over into Asia withsigns of slowdown in India and Vietnam.

David Aufhauser resigns as generalcounsel to UBS’s investment bankingdivision after Andrew Cuomo hadaccused him along with other top levelUBS officials for selling their personalholdings in auction rate securities oninsider information.

August 5, 2008

Northern Rock, the British nationalizedmortgage lender, expects to report firsthalf losses of $500 million tied to baddebts in mortgage.

The UK government is taking on £3.4billion in extra risk to help bail outNorthern Rock in a debt to equity swapwhich meant investors would get the£3.4 billion back only if Northern Rockis sold into the private sector, or itrepatriates excess capital.

August 7, 2008

AIG shares drop 19.1%, its biggest dailydrop in 39 years, after announcement ofa higher than expected $5.4 billionsecond quarter loss.

Barclays offloads £6.3 billion in troubledloans and securities in a move totransfer the risk of the credit crunch offits balance sheet.

Investors were still willing to buy debtassets affected by the credit crunch.

August 8, 2008

Fannie Mae announces a $2.3 billionsecond quarter loss and slashes itsdividend.

Citigroup and Merrill Lynch agree to buyup to $20 billion in auction-ratesecurities (ARS) after pressure fromregulators claiming banks had continuedto sell ARS as liquid instruments.

Royal Bank of Scotland announces a£691 million loss, the third largest in UKbanking history with £5.9 billion in writedowns.

August 9, 2008

UBS reaches an agreement withregulators to repurchase $19 billion inARS debt. The agreement also settlesthe civil lawsuits brought by AndrewCuomo against UBS.

August 10, 2008

Financial Times reports that the RoyalBank of Scotland is involved in a sale of$8 billion in loans from their balancesheet. The buyout is led by privateequity firms Apollo, Blackstone, andTPG.

Buyers are expected to make up to 30%on the deeply discounted loans.

These deals are structured in such away that the private equity companiesare at risk for the first losses of up to20 cents on the dollar, but then anyadditional losses are shared with thebanks.


August 11, 2008

A Moody’s report shows the default rateon UK subprime mortgages increasedfrom 7.3% in the second quarter of 2007to 10% in the second quarter of 2008.

UK mortgage lenders predict a 20% dropin housing prices by the end of 2009.Data from the UK Building SocietiesAssociation shows that mortgagerepayments outstripped new loans by£700 million in June bringing net lendingin the mortgage market in the negative.

August 13, 2008

UK inflation rate exceeds bank interestrate for the first time in twenty sevenyears.

Bank of England is expected to respondby raising interest rates to controlinflation instead of lowering themfurther to ease the credit crunch.

August 27, 2008

Bloomberg reports total losses relatedto the failure of the US subprimemortgage market have topped $500billion, with banks raising $352.6 billionto cover their writedowns.

September 7, 2008

Subprime mortgage collapse wipes outmore than $17 trillion in global equityvalue.

US government takes control of FreddieMae and Fannie Mac by injecting $100billion to ensure the troubled mortgagelenders would be able to meet theirdebts.

The government also says it would buymortgage bonds backed by thecompanies starting with $5 billion andprovide unlimited liquidity until the endof 2009.

Current shareholders face the prospectof massive dilution. Freddie and Fanniehave $5,400 billion in outstandingliabilities and guarantee three-quartersof all new US mortgages.

September 11, 2008

Lehman Brothers announces plans tosell off its asset management unit andspinning-off $30 billion of troubledproperty assets after Lehman reportedits worse loss ever of $3.9 billion for thethird quarter spurred by $7.8 billion incredit related writedowns.

September 13, 2008

Bank of America considers a jointtakeover bid of Lehman Brothers with JCFlowers and China Investment Co., aChinese Sovereign Wealth Fund (SWF).

The US Treasury and Federal Reserverefuse to use public funds to close a

rescue for Lehman Brothers, as opposedto the government bailout of BearStearns.

Analysts highlight three importantdifferences between Lehman and BearStearns:

i) business mix differs from Bear’s, ii) less systematic risk with Lehman’s

failure; and iii)Fed’s emergency liquidity facility to

allow Lehman to wind down business in a way that will not cause shocks to the markets.

September 14, 2008

Merrill Lynch is in talks to be acquiredby Bank of America after BofA removeditself from the bidding for LehmanBrothers.

American International Group (AIG)seeks to raise $10-20 billion in equityfrom private investors to shore up itsbalance sheet.

AIG also petitions the Fed to borrowfrom its discount window after ratingsagencies threaten to downgrade AIG.

September 15, 2008

AIG, the world’s largest insurancecompany, goes bankrupt. Lehman filesfor bankruptcy.

Lehman Brothers files for Chapter 11bankruptcy after acquisition talks withBank of America break down.

Ten* of the world’s largest banks agreeto pool $70 billion in a liquidity fund tomitigate the expected failure of LehmanBrothers.

*Bank of America, Barclays, Citigroup, Credit Suisse,Deutsche Bank, Goldman Sachs, JP Morgan Chase,Merrill Lynch, Morgan Stanley, and UBS.

Bank of America agrees to acquireMerrill Lynch for $50 billion. The allstock transaction signals that investmentbanks were scrambling to find partnersafter the fall of Lehman.

European Central Bank (ECB) allots €30billion in one-day liquidity to counter

the effects of Lehman Brothersbankruptcy. Bank of England says itwould offer £5 billion of extra reservesto help stabilize the markets.

A deal between AIG and New Yorkinsurance regulators allows theinsurance company to access $20 billion of assets from its subsidiaries in an attempt to add liquidity and prevent acredit downgrade.Yet, all the major rating agenciesdowngrade AIG’s long term debttriggering billions of dollars in collateralpayments on its derivative trades, inaddition to the billions AIG owed to itstrading partners. AIG is bankrupt.

AIG’s largest trading partner wasGoldman Sachs. The minute AIG wentbankrupt, Goldman Sachs lost $20billion in CDS exposure to AIG.

September 16, 2008

US Federal Reserve announces it willlend AIG $85 billion in emergency fundswith a 79.9% government stake in thecompany to prevent existingshareholders from benefiting from thebailout.

AIG executives would be replaced andthe $85 billion bridge loan would berepaid by selling off assets.

Russian central bank injects $14.16billion in emergency one-day funds in aneffort to stabilize the money market,after a 20% drop in trading on its twostock exchanges Micex and RTS.

September 17, 2008

The first time since 1994 the net assetvalue of a money market fund managedby US Reserve Management Corporationdrops to 97 cents, i.e. below $1 pershare.

RMC had written down $785 millionheld in Lehman Brothers debt to zero.

Financial Services Authority and UKgovernment agree to waive competitionrules to allow a £12 billion takeover ofHBOS, UK’s largest savings institution, byLloyds TSP.

The merged bank would have around28% of the mortgage loan market and50% of the savings market.

September 18, 2008

Following the AIG bailout, Interbanklending in the US and UK falls.


Central banks from around the worldannounce $180 billion in emergencyliquidity.

September 19, 2008

In response to the Russian government’spledge to pump $100 billion in liquiditythe Russian stock market gains 30%after suspension of trading for two days.

Standard & Poor’s downgrades Russia’seconomic outlook from positive tostable.

Financial Services Authority approvesban on short-selling of financial stocks inthe UK until January 16, 2009.

US Treasury announces it will provide upto $50 billion from the ExchangeStabilization Fund to insure moneymarket mutual funds in an attempt toprevent a run on the funds. Moneymarket funds hold more than $3,400billion in investor funds.

Treasury Secretary Henry Paulson urgesCongress to pass legislation to allow thegovernment to buy up to $700 billionworth of toxic mortgage securities fromthe banks.

September 21, 2008

Russian finance ministry announces$24.21 billion in additional funds to thebanking system in the form of threemonth bonds. More Russian banks aregiven access to budget funding.

September 22, 2008

Australia, Taiwan, and the Netherlandsannounce ban on short-selling.

US Federal Reserve approves GoldmanSachs and Morgan Stanley as bankholding companies, subjecting them tothe Fed’ capital requirements. Thesewere the last two large standaloneinvestment banks.

September 24, 2008

Goldman Sachs announces it will receivea $5 billion capital infusion from WarrenBuffett’s Berkshire Hathaway, and raisean additional $2.5 billion from publicsale of common shares.

Rumors about insufficient liquidity atthe Bank of East Asia, Hong Kong causesa run on the bank. BEA denies therumors.

September 25, 2008

In a televised address US PresidentGeorge W. Bush pleads with the US

public to support the $700 billiongovernment bailout plan, or risk a longand painful recession.

September 26, 2008

WaMu becomes the biggest bankfailure in US history

US regulators seize the assets ofWashington Mutual (WaMu), the sixth largest US bank, which had lost aquarter of its share value the daybefore.

WaMu had failed to auction itself topotential buyers becoming the biggestbank failure in US history.

JP Morgan acquires WaMu’s troubledassets, bank deposits, and mortgageportfolio from the federal governmentfor $1.9 billion.

UK government nationalizes Bradford &Bingley after retail savers withdraw tensof millions of pounds in recent days.

Spanish bank, Santander, agrees to buyB&B’s £21 billion deposit book andbranch network for around £600 million.

September 28, 2008

After WaMu’s seizure, its leftoverholding company, Washington MutualInc., files for Chapter 11 bankruptcylisting more than $8 billion in totaldebts.

At the World Economic Forum in Tianjin,China policymakers discuss the need fora set of international accountingstandards, policing of the CDS market,and greater international cooperationbetween regulators.

September 29, 2008

Known as the ‘bailout bill’, theEmergency Economic Stabilization Actwas put to the US House ofRepresentatives. The Act allowed theTreasury to spend up to $700 billion onthe Troubled Assets Relief Program(TARP) to buy and hold troubled loan-based assets, many of which are tied toslumping home prices in the US.

The US House of Representatives votesagainst the $700 billion bailout billproposed by the Treasury.

In response, the S&P 500 Index falls8.8%, its worst drop since 1987 and theDow Jones Industrial Average falls 778points—its worst points decline ever.Citigroup agrees to buy the banking

operations of Wachovia, the sixthlargest lender in the US for $2.2billion.The takeover will turn Citi intothe largest retail bank in the US withmore than $600 billion in deposits andmore than 4,300 branches.

FDIC agrees to provide a cap on lossesof Wachovia’s $312 billion mortgageportfolio. In return FDIC will receive a$12 billion stake in Citi in the form ofwarrants and preferred shares. Citi willbe responsible for the first $42 billionin losses with the FDIC covering anyadditional losses.

US Federal Reserve more than doublesits swap lines with the European CentralBank and other central banks from $290billion to $620 billion.

The European Central Bank along withthe governments of the Netherlands,Belgium, and Luxemburg agree to pitchin €11.2 billion to nationalize Fortis, theEuropean banking and insurance giant.

Hypo Real Estate, one of Germany’sbiggest lenders, is rescued by theGerman government and other banksafter a €50 billion liquidity crisis. HREsells off €15 billion of assets to helpcover the liquidity shortfall.

The government of Iceland takes controlof Glitnir, the country’s third largestbank. The government had injected€600 million of equity into the bank.

Neuberger Berman, the assetmanagement arm of Lehman BrothersHoldings, is sold to Bain Capital andHellman & Friedman for $2.15 billion.

A month before Lehman’s collapse,Carlyle was prepared to pay $7 billionfor Neuberger which would haveallowed Lehman to buy back the asset.

September 30, 2008

Ireland guarantees around €400 billionof liabilities and €100,000 of individualdeposits of six of its largest banks.

Dexia, a Franco-Belgian bank specializingin local authority finance, gets a €6.4billion capital injection from variousEuropean governments including €3billion from Belgium, €3 billion fromFrance, and €376 million fromLuxembourg.

The governments contend Dexia’sfailure would have causedunacceptable systematic risk to theirfinancial systems.


October 1, 2008

End of an era: Structured Investmentvehicles (SIVs) are the latest casualty ofthe credit crisis

With $27 billion in managed funds,Sigma Finance in the US becomes thelast of the structured investmentvehicles (SIV) to be liquidated after JPMorgan cuts its last funding line.

SIVs are debt funds that borrow short-term commercial paper and lend longat a higher interest rate; the creditcrunch prevented financing of long-term debt. The SIV industry had oncecontrolled over $400 billion.

MBIA files a lawsuit chargingCountrywide Financial (which has beenacquired by Bank of America) forfraudulently inducing MBIA to guaranteebillions of dollars in its mortgage bonds.

October 3, 2008

The revised bailout plan passes throughthe US House of Representatives and issigned into law by President Bush.Amendments in the bill include anincrease in the FDIC insurance on bankdeposits.

October 4, 2008

Wells Fargo announces it will pay $15.1billion in an all-share offer to purchaseWachovia after the $2.2 billiongovernment engineered deal withCitigroup falls through.

Citigroup says it plans to file for aninjunction to prevent the deal orsubstantial damages from Wells Fargo.

October 6, 2008

French President, Nicolas Sarkozy, hostsan emergency summit on the globalfinancial crisis in Paris where leaders ofFrance, Germany, UK, and Italy agreethat Europe will not allow any bank tofail.

Bank of America agrees to settle claimof predatory lending charges againstrecently acquired Countrywide Financial.BofA says around 400,000 borrowerswill benefit from the deal.

Danish government announces plan toguarantee all banking deposits andsome inter-bank loans, in return forwhich the country’s banks mustestablish a rescue fund of $6.5 billion.Iceland passes legislation allowinggovernment to nationalize, merge, or

force ailing banks into bankruptcy, andto take over housing loans held by banksand put them into a governmenthousing fund.

BNP Paribas takes over Fortis from theBelgian government for €14.5 billionmaking BNP the largest bank in theEurozone.US Federal Reserve is in the process ofcreating a central clearing house forcredit default swaps.

October 7, 2008

Dow Jones Industrial Average falls below10,000 for the first time since 2004.

Iceland nationalizes Landsbanki, thesecond largest bank in the country andturns to Russia for a €4 billion loan tohelp stabilize its financial situation.

Spain announces the formation of a€30-50 billion emergency fund toprovide liquidity by buying Spanish bankassets. Spanish government announcesit will increase its guarantees for bankdeposits from €20,000 to €100,000.

Russia injects $37 billion in long-termsubordinated loans into state controlledbanks through Russia’s two largest statebanks, VTB and Sberbank.

October 8, 2008

For the first time since September 11,2001 the European Central Bank and theUS Federal Reserve work together tobring a half-point rate cut to stop thedamage from the credit crisis.

UK government launches a £400 billionrescue plan to help restore confidence inthe financial markets by investing £50billion in the banking industry,guaranteeing £250 billion of new bankdebt, and adding £100 billion to theexisting Bank of England short-term loanscheme.

UK government declares it will sueIceland to recover all UK customerdeposits in Icesave, the failed internetbank that was nationalized. Icesave hasabout 300,000 UK customers.

The Swedish division of Iceland’s largestbank, Kaupthing, receives a SK5 billionloan from Sweden’s central bank.

October 10, 2008

Spillover effects are felt in Asia. SouthKorean banks are seen as the mostvulnerable in Asia due to theirdependence on foreign funding. US

Federal Reserve extends $740 billionvia dollar swap lines to 14 centralbanks, including those in South Koreaand Singapore.

The credit crisis begins to dig its claws into Japan as Yamato Life files forbankruptcy becoming the first directJapanese victim of subprime. YamatoLife had $2.7 billion in liabilities at thetime of the filing.

October 11, 2008

Dow Jones Industrial Average caps itsworst week ever with the highestvolatility day in its 112 year history.Paper losses on US stocks total $8.4trillion from the market highs in 2007.

October 13, 2008

French president, Nicolas Sarkozy,pledges €360 billion in liquidity toFrench banks including €320 billion inguarantees for new bank debt and a €40billion fund for recapitalizing lenders.

Spain announces up to €100 billion ofguarantees for new debt issued bycommercial banks in 2008.

UK government starts its nationalizationprocess by injecting £37 billion in thenation’s three largest banks by owning amajority share in RBS and over a 40%share in Lloyds and HBOS.

In a coordinated move the US FederalReserve, European Central Bank, theBank of England and Swiss NationalBank announce they will provideunlimited liquidity at a pre-fixed interestrate for dollars over periods of sevendays, one month, and 84 days.

Bank of Italy announces it will provide€40 billion in treasury bills to banks torefinance inferior assets that can not becurrently used as collateral.

Germany approves a plan to inject €500billion into credit markets, and theDutch government announces it willguarantee interbank lending up to €200billion.

October 14, 2008

The US taps in to its $700 billion bailoutfund to inject $250 billion of publicmoney into the US banking system bytaking an equity position in banks thatchoose to participate in the program inexchange for certain restrictions such asexecutive compensation.

Bank of America, JPMorgan Chase, Wells


Fargo, Citigroup, Merrill Lynch, GoldmanSachs, Morgan Stanley, Bank of NewYork Mellon and State Street agree toparticipate to receive half of the totalfunds.

The plan also allows the FDIC totemporarily guarantee the senior debtof all FDIC-insured institutions andincrease access to funding forbusinesses by announcing further detailsof the commercial paper funding facility.

United Arab Emirates’ ministry offinance adds a $19 billion in liquidity todomestic banks bringing the total to$32.7 billion.

Japan announces a plan to help steadythe Japanese market by liftingrestrictions on companies buying backtheir shares, strengthening disclosure onshort selling, and temporary suspensionof the sale of government-owned stocks.

The Australian government unveils a$10.4 billion stimulus package to helppensioners, low and middle incomefamilies, and first time home buyerswithstand the economic slowdown.

October 15, 2008

Greece announces a €28 billion packageto support the banking sector includingguarantees for up to €15 billion ofmedium-term lending and €8 billion ofspecial government bond issues.

October 16, 2008

Citigroup announces a third quarter lossof $2.8 billion after receiving a $25billion injection from the USgovernment.

Switzerland agrees to fund a vehicledesigned to hold up to $60 billion oftoxic debt held by UBS, and also injects€3.9 billion to help recapitalize UBS. TheSwiss government will own almost 10%of UBS.

Credit Suisse declines governmentassistance to turn to private equity toraise SFr10 billion, making it the bestcapitalized financial institution inEurope.

October 17, 2008

European Union leaders sign off on ajoint $2.7 trillion bank bailout plan aftera 2-day summit in Brussels. Newinternational supervisory boards for atleast 30 of the world’s largest banks areconsidered.

The won and Seoul stock market fallprompting South Korea to announceplans to raise spending and cut taxes tostabilize its economy.

Singapore and Malaysia both announceblanket guarantees on bank depositsuntil December 2010.

October 19, 2008

South Korean government announces a$130 billion rescue package for its banksand companies. The government willinject $750 million into the IndustrialBank of Korea to help enhance itscapital base.

October 20, 2008

The €500 billion German bank rescuefund is up and running but a €10 billionlimit may be set for a single bank alongwith a €5 billion maximum value ofassets per bank.

Iceland seeks a $6 billion rescue packagefrom the International Monetary Fundto help stabilize its economy.

The French government announces itwill inject €10.5 billion into France’s sixlargest banks Credit Agricole, BNPParibas, Societe Generale, CreditMutuel, Caisse d’Epargne, and BanquePopulaire.

Sweden announces a $205 billionprogram to stabilize its financial systemand boost liquidity.

October 21, 2008

US Federal Reserve announces it willspend $540 billion to purchase short-term debt from money market mutualfunds to help unfreeze the creditmarkets making it easier for businessesand banks to obtain loans.

UK announces plans for a £3 billion loanto the government of Iceland to helpunfreeze the assets of over 300,000British savers who had deposits withIcesave.

October 22, 2008

Wachovia announces third quarterlosses of $23.9 billion.

The run on the bank before its sale toWells Fargo included depositor’swithdrawal of more than $26 billion or24% of their deposits, the biggest lossany bank has impaired since thebeginning of the credit crisis.

October 24, 2008

AIG has borrowed a total of $90.3 billionof the $123 billion rescue fund set up bythe government. The money has beenused to pay off bad debts incurred byAIG’s CDSs.

October 26, 2008

International Monetary Fund announcesa proposed $16.5 billion loan to Ukraineto mitigate the effects of the globalcredit crisis.

Kuwait guarantees all local bank depositsand suspends trading in Gulf Bank, thenation’s second largest bank, after someclients dealing in derivatives refused tohonor their commitments. This actionwas the first of its kind in Kuwait.

October 27, 2008

Bank of Korea cuts interest rates by 75basis points and says it would buy up to$7 billion of bank bonds to providemore liquidity.

The central bank agrees to allowexporters to borrow dollars to pay forforeign exchange losses and smallcompanies to roll over foreign-currencydebt for one year.

October 28, 2008

According to Bank of England estimatesthe world’s financial firms have now lost$2.8 trillion as a result of the globalcredit crisis.

Chairman Gulf Bank resigns overderivative losses and a run on Kuwait’ssecond largest bank, which is the firstpublicly known bank run in the MiddleEast.

World Bank, IMF and the EuropeanUnion agree to provide Hungary $1.3billion, $15.7 billion, and $8.1 billionrespectively. This is the largestinternational rescue package for onecountry and the first for an EU membercountry since the crisis began. TheHungarian economy was heavilydependant on foreign financing.

US Federal Reserve announces atemporary reciprocal currencyarrangement with the Reserve Bank ofNew Zealand. The swap agreement willhelp ease pressures in the US dollarshort-term funding markets.

October 29, 2008

The Fed, the Banco Central de Brazil, theBanco de Mexico, the Bank of Korea,


and the Monetary Authority ofSingapore announce a temporary swapline between the banks.

Kuwaiti parliament votes to guaranteearound $86 billion all bank deposits ofall local and foreign banks.

October 31, 2008

As a corollary to the subprime, globalcredit card revenues decline 40% asrising unemployment and job cuts forceborrowers to default

Citigroup announces a $1.4 billion losson securitized credit card loans in thethird quarter of 2008.

Credit card loans were largelysecuritized in the same way mortgageshad been.

Back-door Bailout for Big Banks

Flashback November 2008

The New York Federal Reserve boughtout, for about $30 billion, credit defaultswaps that AIG had sold on toxic debtsecurities to banks including GoldmanSachs Group, Merrill Lynch & Co.,Societe Generale and Deutsche Bank.

Fast Forward February 2010

The US Congressional Committee onOversight and Government Reform iscurrently hearing the case of AIG’sbailout, which involved a secretivegroup deploying billions of dollars tofavored banks operating with littlepublic or government oversight.

November 1, 2008

J.P. Morgan Chase announces a plan torestructure $70 billion in mortgages foran estimated 400,000 borrowersdefaulting on payments.

November 3, 2008

South Korea announces plans to pumpan extra $11 billion into their economyin 2009. Economic growth in the countryhas fallen to its lowest level in a decade.

HBOS, UK’s largest mortgage lender,reveals writedowns of £5.18 billion forthe nine months ending in Septemberincluding £457 million on HBOS’sexposure to Lehman Brothers andWashington Mutual.

November 4, 2008

Generally considered immune to thecredit crisis, Latin American bankssuffer from sharp currency declines

Two of Brazil’s largest banks agree tomerge. Itaú Holding Financeira SA,Brazil’s second largest non-state bank,will purchase its smaller rival, Unibanco,to create Latin America’s largest bank.Contrary to analysts’ expectations, SwissRe, one of the world’s largest reinsurers,announces a $263 million loss with a289 million Swiss francs writedown onits credit default swap portfolio duringthe quarter.

November 5, 2008

Expecting to earn up to $550 billion byend 2008, the US Treasury offers its first“bailout bond” which will reach maturityin three years at a fixed rate of interestevery six months.

Bond insurers MBIA and Ambacannounce losses of $806.5 million and$2.43 billion leading to a likely creditrating downgrade. There is speculationon whether the two would be able toget anything from the $700 billion TARP.

November 9, 2008

AIG receives a revised $150 billiongovernment bailout plan to reduce itsinterest payments and give it more timeto sell assets. The total rescue packagegiven to AIG now amounts to $150billion.

November 10, 2008

Eastern Europe is most affected by thecrisis because of large current accountdeficits and external financing needs

Fitch downgrades emerging markets ofBulgaria, Hungary, Kazakhstan, andRomania.

Fitch also revises long-term foreigncurrency ratings for South Korea,Mexico, Russia, and South Africa fromstable to negative.

November 11, 2008

With little presence in retail banking,American Express converts to a bankholding company which would give itpermanent access to low-cost FederalReserve funds, but stricter regulatoryand capital requirements.

Out of total assets of $127 billion,AmEx has only $7.2 billion in retaildeposits.

November 12, 2008

US Treasury Secretary Henry Paulsonabandons plan to buy toxic assets with

the $410 billion remaining in the $700billion TARP.

Instead, the Treasury evaluates arecapitalization scheme to provide amatch of public funds to any fundsfinancial institutions are able to raisefrom private investors.

November 14, 2008

S&P downgrades Turkey’s sovereigncredit outlook from stable to negative.Turkey’s request for IMF assistanceseems inevitable.

After announcing a quarterly loss of$25.3 billion, Freddie Mac asks the USgovernment for access to $13.8 billionfrom the $200 billion facility created atthe time of nationalization of Freddieand Fannie.

Fannie Mae reports a $29 billionquarterly loss and asks for more than$100 billion to stay afloat.

November 15, 2008

G20 meets in Washington DC to focuson five policy measures: i) strengthentransparency and accountability; ii)improve regulation; iii) promote marketintegrity, iv) reinforce cooperation; andv) reform international institutions.

November 17, 2008

In the second round of TARPdisbursements, US Treasury gives out$33.6 billion to 21 banks bringing totalpayout so far to $158.56 billion.

November 24, 2008

Total capital infusion in to Citigroupcomes to $45 billion

US Federal Reserve, Treasury andFederal Deposit Insurance Corporationagree to cover remaining losses forCitigroup after the bank agrees toabsorb the first $29 billion of a pool of$306 billion identified toxic assets heldby it.

November 25, 2008

US Federal Reserve pledges $800 billionmore $600 billion will be used to buymortgage bonds issued or guaranteedby Fannie Mae, Freddie Mac, FannieMae and Ginnie Mae, and the FederalHome Loan Banks.

The other $200 billion will be used tofund the term asset-backed securities


loan facility (Talf) which will lend moneyto holders of AAA-rated securities thatare backed by student loans, auto loans,credit card loans, and small businessloans.

November 30, 2008

World Bank launches a DebtManagement Facility (DMF) to help lowincome countries achieve debt stability.Governments of Austria, Belgium,Canada, The Netherlands, Norway, andSwitzerland make initial commitments of$12 million to the facility.

December 9, 2008

Russia is the first G8 country to receivea ratings downgrade

S&P downgrades Russia to BBB citingdepletion of forex reserves and possibledifficulties in meeting external financingneeds.

In order to prevent US creditor lawsuits,Landsbanki, the nationalized Icelandbank, files for Chapter 15 bankruptcy inthe US.

December 16, 2008

Goldman Sachs reports a $2.12 billionfourth quarter loss its first quarterly losssince it became a publicly tradedcompany in 1999.

December 17, 2008

In a surprise move, the US FederalReserve lowers interest rates to a rangeof 0-0.25.

December 19, 2008

Collapse of Detroit Three - GeneralMotors, Chrysler & Ford

President George W. Bush announcesplans to lend $17.4 billion to GeneralMotors and Chrysler with $13.3 fromTARP.

IMF outlines a plan to loan $2.4 billionto Latvia.

Bank of Japan cuts interest rates to0.1%.

December 20, 2008

S&P downgrades credit ratings of elevenof the world’s largest banks including JPMorgan Chase, Bank of America, WellsFargo, Citigroup, Morgan Stanley,Goldman Sachs, Barclays, Credit Suisse,Deutsche Bank, Royal Bank of Scotland,and UBS.

December 22, 2008

Worldwide M&As suffer

At $3,280 billion, worldwide mergersand acquisitions are down 29% from2007 owing to lack in financing,valuation fluctuation, and widespreadrisk aversion.

China cuts interest rates to 5.31%, itsfifth cut in the last three months. In aneffort to restore China’s high growthrate People’s Bank of China reduces itscapital reserve requirement by 50 basispoints.

The beginning of 2009 saw the rest ofthe world engulfed in the recessionthat hit the advanced economies. Therewere calls from policymakers to cleanup the banking sector to preventworldwide recession.

January-March 2009

Credit Crisis Continues to Take Root inAsia.

Central banks around the world cutinterest rates to record lows —- nearzero in the US and Japan while pumpingtrillions of dollars, known as quantitativeeasing, in to the banking system to helprestore credit flows.

In January the IMF warned that “theworld economy is facing a deeprecession.” Towards the end of January,IMF announced a significant downwardadjustment in its forecasts for globaleconomic growth. By now, the IMF hadcontributed $50 billion to membercountries in response to the globalfinancial crisis.

In the first quarter of 2009 US GDP sank6.4%. Unemployment in the UnitedStates jumped to 7.2%, its highest in 16years. Jobs were being lost at a pace of700,000 per month. Eurozone saw a2.5% slide in GDP, a potential 10 percentannualized drop in the first quarter, theworst on record.

Japan’s economy was falling at a rate of14.2%. The Bank of Japan reduced

economic forecasts for the next twoyears admitting it could face deflation.The bank also planned to inject capitalinto the markets by buying corporatedebt to allow businesses to raise money.Japan announces a $16.7 billionstimulus package. China announced theslowest growth of 7.7% in seven years,and South Korea reported the firstdecline in quarterly economic growthsince the Asian financial crisis.

A study by the Boston Consulting Groupshowed market value of the world’sbanks has depleted by $5.5 trillionequivalent to 10% of the world’s GDP.

US Treasury Secretary Timothy Geithnerintroduced his $2 trillion FinancialStability Plan in an attempt to clean upthe US financial system. US Treasuryalso announced details of its CapitalAssistance Program (CAP) that includedrunning stress tests on banks todetermine if they will require additionalcapital.

UK government announced its AssetProtection Scheme (APS) to insure $712billion of banks’ toxic assets. APS aims toincrease lending without having to fullynationalize the banking system. RoyalBank of Scotland reported a £24.1billion loss for 2008, the largestcorporate loss in Britain’s history. UKgovernment released plans to inject£25.5 billion into RBS, and to absorb£325 billion of its toxic assets into theAsset Protection Scheme.

An Asian development Bank studyshowed the value of global financialassets tumbled $50 trillion in 2008. TheAfrican Development Bank (AfDB) set upa $1.5 billion emergency bailout fund tohelp alleviate the impact of the globalfinancial crisis in Africa.

April-June 2009

A modest second half comeback inmost of the world

G20 leaders pledge $1.1 trillion to fightthe global financial crisis with $750billion in additional funding for the IMF,$250 billion for world trade financing,and $100 billion for multilateraldevelopment banks.

The Financial Accounting StandardsBoard (FASB) announced a relaxation inmark-to-market rules. The changes willallow companies more discretion inaccounting for toxic assets allowingbanks to value their distressed assets


2009

higher. The mark-to-market rule hadbeen blamed by many to haveexacerbated the credit crisis by forcingbanks to write down their assets.

IMF’s Financial Stability Reportprojected total writedowns on USoriginated assets to reach $4 trillion. UScar maker Chrysler filed for Chapter 11bankruptcy and announced partnershipwith Italy’s Fiat marking Fiat’sreentrance into the US car market.

Stress test results for the 19 largest U.S.banks are released. Nine banks includingJP Morgan Chase, Goldman Sachs andMetLife, are found to be adequatelycapitalized. Of the 10 most vulnerablebanks GMAC, Wells Fargo, Bank ofAmerica and Citigroup, as well as severallarge regional banks like Keycorp andSunTrust Banks lack capital to withstandthe worst-case scenario simulations.These banks are asked to preparecapital-raising plans by June 8 which willbe implemented by November 9.

Under worst-case assumptions, expertsput potential losses at $600 billion andthe likely mortgage failure rate at 1 in 10.

Since its March 2009 low, the MSCIemerging markets index gained 68percent compared with a 43 percentgain in the developed markets indexthough there are still significantreductions in capital flow, exportdemand, and foreign investment.

In the largest manufacturing bankruptcyin American history, US automakerGeneral Motors filed for Chapter 11bankruptcy.

Eurozone GDP saw a 2.5% overalldecline. German economy contracted4%. This was the worst recession inEurope since World War II. Industrialproduction was down 21.6%. Eurozonebanks needed to writedown $283 billionmore by end 2010. Rising corporatedefault and falling property prices werecause for concern.

Ten US banks are allowed to exit theTARP including American Express,Goldman Sachs, Morgan Stanley andJPMorgan Chase. Altogether they willreturn $68.3 billion, more than aquarter of the federal bailout moneyissued by TARP since October 2008.Chinese leaders proposed expandingIMF Special Drawing Rights for use asinternational reserve currency tocounter the role of the dollar.The European Central Bank lent a record

$622 billion to Eurozone banks at thecurrent key rate of 1 percent whichreflected continued funding problems inEurozone banks amid expectations thatthe region’s economy will beginrecovering in 2009.

July-September 2009

US economy expanded at a 2.2% pace inthe third quarter after four quarters ofcontraction. Japan grew at a moremoderate pace of 1.3% in July toSeptember. Eurozone saw a sluggish0.4% growth over the quarter after fivequarters of contraction. China saw aslowdown but avoided recession. Builton stimulus cash and bank lending,China’s third quarter growth was 8.9%.

Common problems arising from thecredit crisis are identified as ineffectiveintegration of risk into decision making,a lack of alignment between companies’strategies and appetites for risk, and alack of timely data. According toAccenture’s 2009 Global RiskManagement Survey 85% of corporateexecutives believed their companiesneeded to overhaul their approaches tomanaging risk.

October-December 2009

In October the IMF projected globalgrowth at 3.1% in 2010, after anestimated 1.1% global contraction in2009. Economists said whatever badassets have been resolved have almostentirely been placed on the books ofgovernments and central banks in placeslike Dubai , Mexico , Spain , Greece , theUK and the Baltic states, even at statelevel in the US . Japan announced itsworst performance in 30 years as itseconomy shrank by 3.3% in the fourthquarter.

By November the impact of the financialcrisis had its most severe impact oncountries where the pre-crisis excesseshad been greatest, i.e. the US and theUK among the G7 countries. Accordingto the IMF the levels of GDP and fiscalrevenue in these countries will notreturn to the previous path. In the caseof UK , the IMF forecasts that the crisiswill raise the ratio of net public debt toGDP by close to 50 percentage pointsbetween 2007 and 2014.

In the context of the global credit crisis,the role of credit ratings agencies hasalso come under a lot of fire. The threebiggest ratings agencies ----Moody’s,Standard & Poor’s and Fitch --- controlover 90% of the market. These agencies

have been blamed for awardingexcessively high ratings on mortgage-backed bonds that turned out to bealmost worthless. These agencies makemoney by charging the bond issuers toevaluate the risks of their debt offerings,which in the aftermath of the creditcrisis, has been criticized as a potentialconflict of interest.

The US Securities & ExchangeCommission approves a ratings agencyas a Nationally Recognized StatisticalRating Organization (NRSRO) whichsignifies that a ratings agency is credibleand reliable. European securitiesregulators and bankers have longpressured the SEC to break up the threeagencies’ monopoly, or make themmore accountable for issuing bogusratings.

Entries for Living In a Bubble have beendrawn from news reports, press releases andstatements from the following sources:

www.associatedpress.comwww.news.bbc.co.ukwww.bloomberg.comwww.businessweek.comwww.money.cnn.comwww.sec.gov/news/presswww.europa.eu/rapidwww.imf.org/external/pubswww.financialstability.gov/latestwww.ft.comwww.nytimes.comwww.reuters.comwww.marketwatch.comwww.cnbc.comwww.ustreas.gov/press/releases/reportswww.time.comwww.guardian.co.uk


Living In aBubble: The Credit Crisis at Your Fingertips

This SpecialReport providesa chronology ofevents leadingup to, andculminating in,the recentglobal creditcrisis.

Due care hasbeen taken toensure accuracyof dates, events,and analysis.


When Your High PotentialFemale Employees Start to Leave

CA S E V I G N E T T E

Inresearching her forthcoming book Top Talent: KeepingPerformance Up When Business Is Down*, author Sylvia

Ann Hewlett, an economist and founding president of the Centerfor Work-Life Policy, found that in the wake of last year’s financialcrash, high-powered women were more than twice as likely asmen — 84 percent compared with 40 percent — to be seriouslythinking about leaving their jobs.

Research shows that the presence of women in senior positionsin any organization translates in to higher productivity, higherreturn on investment, and greater resilience to downturns. Arecent study from London Business School shows that whenwork teams are split 50-50 between men and women,productivity goes up.

Women are better lateral thinkers, and they bring compassionand idealism to the workplace. Summarizing how valuablewomen are to business, The Economist recently wrote:

“The recent financial crisis proved that the sorts of qualities thatmen pride themselves on, such as risk-taking and bare-knucklecompetition, can lead to disaster. Lehman Brothers would neverhave happened had it been Lehman Sisters.”

Intel created career development workshops aimed squarely atretaining one of its most at-risk populations: mid-level femaleengineers. Data collected from exit interviews had revealed thatmany of these talented technologists were leaving not to spendtime with their family but because they no longer felt challengedby or passionate about their work.

According to Hewlett talented people, both men and women arelooking for intellectually and professionally challenging careersinstead of a traditional vertical career path. “When they don’tknow how to articulate those desires or think they won’t besatisfied by their current employer, they’ll look elsewhere.”

In 1991, Deloitte & Touche got a wake-up call about its efforts toretain women professionals. While it was recruiting almost as

many women as men, thecompany had a much higherturnover rate for women. Whenthey looked harder, they found thatmost women weren’t leaving toraise families; they were leavingafter having weighed theirunpromising career options inDeloitte’s male-dominated culture.

CEO Mike Cook made a businesscase for change. Deloitte heldmandatory, two-day, intensiveworkshops for its 5,000 USmanagers to deliberate on whatwas discouraging high-performingwomen from staying. Deloitte’s

gender gap in turnover has now nearly vanished, and thenumber of women partners and directors is the highest amongthe Big Five. Gender and cultural diversity have enabled Deloitteto grow faster than any of its competitors.

* Source: Harvard Business online

Myth Busted!Most women wholeave their jobs donot leave to spendtime with theirfamily, but becausethey no longer feelchallenged by orpassionate abouttheir work.

I N H O U S E


ccccW O R L D I N F O C U S

State Bank of Pakistan announced its monetary policy onJanuary 30 keeping its benchmark interest rate unchanged forthe next two months as inflation soars due to higher power tariffsand delay in receiving aid from Friends of Pakistan. Thedomestic inflationary cycle is expected to hike over the nextthree months with the increase in utility rates. State Bank of

Pakistan maintained its discount rate at 12.5 percent

SBP projected CPI inflation for the current fiscal between11 and 12 per cent, compared to 20.5 per cent last year.Rise in cotton production and growth in textile sector haveled to increased exports. Large-scale manufacturing sectorgrew by 0.7 per cent in November, compared to minus 20per cent in March.

Overall balance of payments has posted a surplus of $1.4billion during the first half of the current fiscal, compared toa deficit of $4.8 billion during the same period last year.

Sustained improvement in the balance of payments woulddepend significantly on the timing and scale of projectedforeign inflows, especially the officials flows pledged inTokyo by Friends of Pakistan.

SBP Governor Salim Raza said monetary growth wasexpected to be around 14.5 per cent for the current financialyear. The governor dismissed worries about the decline inrupee’s value vis-à-vis the dollar, saying 3.5 per centdeprecation was not very significant, considering that all majorcurrencies had seen a fall in their value against the dollar.

SBP Announces Monetary Policy for Jan-Feb; Keeps Interest Rates Unchanged

I N H O U S E


DP World to Open Port QasimDP World will be opening Port Qasim in Karachi this year. DPCEO Mohammad Sharaf has declined to say what the addedcapacity would be. As part of its international strategy DP World,one of the world’s largest port operators, is focusing on emergingmarkets which have remained more resilient to the globaldownturn.

In the last 12 months DP World has opened new terminals inDjibouti and Vietnam and has seen added capacity from portexpansion in Kochi and Peru.

Pakistani Businesses Pledge Projects at FoDPLed by Foreign Minister Shah Mahmoud Quraishi, a delegationof Pakistani businessmen has pledged to offer private-publicsector projects to international investors in Dubai. The UAEhosted the Public-Private Partnership conference in Dubai underthe aegis of Friends of Democratic Pakistan (FoDP). Theconference is expected to provide an excellent opportunity tolocal businesses and foreign investors to directly obtain andprovide information.

Real Estate Speculation Raises Bubble Fears inChinaChina’s property prices rose at the fastest pace in 18 months inDecember with residential and commercial real estate prices in70 cities climbing up to 7.8 percent from a year earlier signalingthe risk of asset bubbles. Home prices have become excessivein some coastal cities with newly built apartments in Shanghaiclimbing 9.2 percent.

As a crackdown measure on speculation, Chinese Premier WenJiabao pledged to stabilize property prices and keep housingaffordable through taxation, differentiated interest rates and landregulations.

Analysts say the tightening focus will be on the luxury housingsegment and speculative buying, not on so called ‘ordinary’housing. If the market cools to the extent that no one’s buyingthen the 2010 economic growth target will be jeopardized. Realestate investment is equivalent to almost 10 percent of China’seconomic output.

Ben Bernanke Appointed Federal Reserve Chairmanfor Another TermThe US Senate backed Ben Bernanke for a second four yearterm as Chairman of the Federal Reserve, but he continues toface significant challenges. Bernanke’s political standing hastaken a beating during the past several weeks, which mightmake it more difficult for him to defend the central bank andmaintain its independence.

Obama ‘Crisis Tax’ Threatens Recovery of European BanksA ‘crisis tax’ proposed by the Obama administration would cutsubstantially into bank earnings across Europe and couldsidetrack the sector’s recovery according to analysts andindustry officials.

Under the new tax proposals, financial institutions with balancesheets above $50 billion would be assessed a fee equal to 0.15percent of certain assets. About 15 international firms fall underthat umbrella.

Europe’s three biggest economies were quick to distancethemselves from the proposal given that the European bankswhich would be affected by this levy did not get bailouts in theUnited States and lack many of the guarantees their U.S.competitors received.

German Chancellor Angela Merkel said she favored a financialtransaction tax, Britain said the problems in the United Stateswere uniquely its own, and France said a tax on bonuses wasthe most efficient response to it.

Deutsche Bank was named as likely to be one of the Europeanbanks most affected, given its U.S. exposure.

Break Up the Banks, Says Nouriel RoubiniNouriel Roubini, the economist credited with predicting thefinancial meltdown well before others, says big banks must besplit up.

The New York University economist told business and politicalleaders at the World Economic Forum in Davos, that the Obamaadministration’s planned reforms of banks is a good first step,and it should lead to the separation of commercial banking frominvestment banking around the world.

Emerging Markets To Be Hit As Foreign Investors Pull OutForeign investors withdrew nearly $1 billion from emergingmarket stock funds in the week ended February 3, the most inover a year, according to global fund tracker EPFR Global. Thisincluded $516 million from Asian equities including Japan.

Worsening public debt concerns in Europe and doubts of a USrecovery are driving foreign investors away from risky equitiesforcing them to pull out funds from emerging markets such asIndia where their portfolio holdings total almost $73 billion.Greece, Spain and Portugal are among the three Europeancountries where there is mounting public pressure and threats ofsocial unrest driven by risks of a sovereign default.

Meanwhile, India’s $1.3 trillion economy is being strongly drivenahead by domestic demand and investment. Morgan Stanleyhas raised its forecast for India’s economic growth to 8.5 percentin 2010-2011 from 8 percent earlier.

I N H O U S E


What the CEO Wants You to Know: How Your Company Really WorksRam Charan

What the CEO Wants You to Knowcaptures these insights and explains inclear, simple language how to do whatgreat CEOs do instinctively andpersistently: Understand the basic buildingblocks of a business and use them to figureout how your company makes money andoperates as a total business. Then decidewhat to do despite the clutter of day-to-daybusiness and the complexity of the realworld. Many people spend more than ahundred thousand dollars on an MBA

without learning to pull these pieces of the puzzle together. Manyothers lack a formal business education and feel shut out fromthe executive suite. What the CEO Wants You to Know takes themystery out of business and shows the secrets of success usedby business legends like Jack Welch of GE.

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CIO Best Practices: Enabling Strategic Value with InformationTechnologyJoe Stenzel, Gary Cokins, Bill Flemming, Anthony Hill, MichaelH. Hugos, Paul R. Niven, Karl D. Schubert and Alan Stratton

If you are a Chief Information Officer, orintend to become one, or simply want tounderstand the strategic importance of ITfor your entire enterprise, CIO BestPractices provides you with the bestpractice guidance on the keyresponsibilities of the CIO and its importantrole in modern organizations. This is themost definitive and important work you willfind on achieving and exercising strategicIT leadership.

[email protected] $42.58

The Return of Depression Economics and the Crisis of 2008Paul Krugman

In 1999, in The Return of DepressionEconomics, Paul Krugman surveyed theeconomic crises that had swept acrossAsia and Latin America, and pointed outthat those crises were a warning for all ofus: like diseases that have becomeresistant to antibiotics, the economicmaladies that caused the GreatDepression were making a comeback. Inthe years that followed, as Wall Streetboomed and financial wheeler-dealersmade vast profits, the international crises

of the 1990s faded from memory. But now depressioneconomics has come to America: when the great housing bubbleof the mid-2000s burst, the U.S. financial system proved asvulnerable as those of developing countries caught up in earliercrises and a replay of the 1930s seems all too possible.

In this new, greatly updated edition of The Return of DepressionEconomics, Krugman shows how the failure of regulation tokeep pace with an increasingly out-of-control financial systemset the United States, and the world as a whole, up for thegreatest financial crisis since the 1930s. He also lays out thesteps that must be taken to contain the crisis, and turn around aworld economy sliding into a deep recession.

The book is crafted in Krugman’s trademark style – lucid, lively,and informed – this new edition of The Return of DepressionEconomics sets the debate over how to respond to the crisis.

Available@ amazon.comPrice: $16.47

F E A T U R E D R E A D I N G

The Flight of the Creative Class: The New Global Competition forTalent Richard Florida

For the first time ever, the United States istruly in danger of losing its most crucialeconomic advantage – its status as theworld’s greatest talent magnet – arguesbest-selling author and economist RichardFlorida. Where America was once the firstdestination for foreign students and the laststop for scientists, engineers, musicians,and entrepreneurs wishing to engage in themost robust and creative economy on theplanet, it has now become only one place

among many where cutting-edge innovation occurs.

Burgeoning global technology hotspots. The outsourcing ofingenuity. Rising intolerance. A faltering education system. Citiestorn by inequality. Disconnected political leadership. Accordingto Florida, they all point to the looming creativity crisis that iscausing the decline of American economic might.

In the groundbreaking The Rise of the Creative Class, Floridaintroduced the United States to the rules of engagement in thecreative age. Florida’s 3 Ts of economic development –Technology, Talent, and Tolerance – took him around the worldand back again, sparking an international debate over thecauses and effects of long-term prosperity, development, andinnovation.

The Flight of the Creative Class takes Florida’s arguments to thenext level, explaining how the same conditions that affectregional economic development, talent exchange, and theunleashing of human creativity play out on the world stage.

[email protected]: $19.72

B O O K S


L A S T P A G E

Nouriel Roubini, the economist credited with predicting thefinancial meltdown well before others, says big banks must besplit up. Roubini expects the Obama administration’s plannedreforms of banks to lead to the separation of commercialbanking from investment banking around the globe.

The Obama administration is getting tough with the six largestUS banks with total assets worth more than 60 percent of GDP.The existing business model encourages excessive risk takingby banks. Former Federal Reserve Chairman Paul Volcker hasproposed restrictions on banks similar to those contained in theGlass-Steagall Act of 1933.

The Glass-Steagall Act separated commercial and investmentbanking. The Act was repealed in 1999 allowing institutions suchas Goldman Sachs and Morgan Stanley to transform into bankholding companies from securities firms to get cheap fundingfrom the US Federal Reserve’s TARP program during the recentfinancial crisis. Additionally, if Glass-Steagall had not beenrepealed Bank of America would not have been able to acquireMerrill Lynch.

Policymakers are now calling for a prohibition on proprietarytrading by commercial banks. They are also calling for anincrease in banks’ capital requirements so that the banks hold atleast 20 to 25 percent of assets in core capital. In the US thereare calls to amend the Riegle-Neal Interstate Banking Act of1994 which set a size cap so that no bank could have more than10 percent retail deposits.

The US House of Representatives is planning to reinstate Glass-Steagall. Critics of Glass-Steagall say it would be impractical toroll back the evolution of many financial institutions into globaltrading and banking giants over the past decade, with GoldmanSachs’ finance chief David Viniar saying, “Glass-Steagall wentaway a long time ago.” Whether it’s coming back remains to beseen.

Breaking theBank