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Guideline on the Fair Valuation of Financial Instruments

The Guideline requires financial institutions to establish strong governance and control processes around the fair valuation of financial instruments. The board of directors has the prime responsibility for ensuring that adequate governance structures and control processes are put in place for financial instruments that are measured at fair value. The use of a third-party pricing service for the fair valuation of financial instruments shall not relieve the board of its oversight responsibility or the senior management of its responsibility to ensure appropriate fair valuations and provide supervision, monitoring and management of risks. The Guideline also emphasizes, inter alia, the need for reliable inputs and information sources, allocation of sufficient resources to the valuation process, independent verification, validation processes and consistency in valuation practices for risk management and reporting purposes. A financial institution shall, while selecting appropriate inputs for the valuation process, apply relevant accounting guidance to determine market information and other factors likely to have a material effect on an instrument's fair value. Assessing data sources and input factors is judgmental process in which all facts and circumstances have to be taken into consideration. The fair valuation of financial instruments shall, in the context of outsourcing, be considered as a non-material activity and financial institutions having recourse to a third-party for this activity shall stand guided by the “Guideline on outsourcing by Financial Institutions” issued by the Bank. For financial reporting purposes, a financial institution shall include appropriate risk factors that market participants would consider in determining fair value. To the extent that risks are not incorporated in the valuation estimate or valuation model, the financial institution shall make adjustments to estimates of fair value to ensure the valuation properly reflects all appropriate risks, consistent with a market participant’s view and, in accordance with applicable standards and guidance. Financial institutions shall have a reporting system for proper communication of the entire fair valuation process and valuation estimates.