IFRS quantitative finance series
IFRS 13 Fair Value Hierarchy for Bank Trading and Treasury Books
IFRS 13 defines fair value as a market-participant exit price and organises valuation inputs into a hierarchy. The hierarchy is about observability of significant inputs, not whether the model is simple or whether the trade sits in a liquid business line.
Classify inputs, not models
Quoted unadjusted prices in active markets support Level 1. Observable yield curves, volatilities and credit spreads can support Level 2 when significant inputs are observable. Significant unobservable inputs move the measurement to Level 3 even if other inputs are market-based.
Calibrate and maximise observability
Valuation techniques should be calibrated to transaction price where appropriate and use observable inputs as far as possible. Day-one differences, bid-offer conventions and model changes need controlled accounting treatment.
Govern transfers and disclosures
Transfers between levels should follow a consistent policy and be supported by evidence about market activity and input observability. Level 3 reconciliations and sensitivity disclosures should connect to valuation uncertainty and independent price verification.
Quantitative expression
Implementation controls
- Maintain an input-observability hierarchy.
- Document significant-input judgements.
- Reconcile Level 3 movements to the ledger.
- Validate sensitivity and valuation uncertainty.