Negative Interest in IFRS

Abstract

Since September 2012, IRFS Interpretation Committee has held several meetings, where the issues of negative interest rates and their impact on IFRS accounting system were discussed. The results of these meetings are following: negative interest rate on financial assets is expense, but other than interest expense and negative interest rate on financial liabilities is revenue, but also other than interest yield. Companies such as KPMG or Deloitte expressed their disagreement with this solution in 2013 and 2015. Current analysis of negative interest and its influence on accounting is the topic of this article.

Full text

Negative Interest in IFRS
Mário Papík, Faculty of Management Comenius University, Bratislava, Slovakia,
mario.papik@gmail.com
Abstract
Since September 2012, IRFS Interpretation Committee has held several meetings, where the issues of
negative interest rates and their impact on IFRS accounting system were discussed. The results of these
meetings are following: negative interest rate on financial assets is expense, but other than interest
expense and negative interest rate on financial liabilities is revenue, but also other than interest yield.
Companies such as KPMG or Deloitte expressed their disagreement with this solution in 2013 and 2015.
Current analysis of negative interest and its influence on accounting is the topic of this article.
Keywords: negative interest, interest yield, interest expense, IFRS
Introduction
The main objective of the European Central Bank in a research study by Nováčková and Sysákova
(2015), besides supporting of the banking sector, is to maintain the price stability by keeping the annual
inflation rate close to 2 %. Šlahor et al (2015) mentioned when the inflation is higher than 2 %, the
European Central Bank will raise the interest rates. Consequently, loans become more expensive and to
generate savings becomes more interesting for clients. When the inflation is much lower than 2 %, central
bank will decrease the interest rates. Then the loans are cheaper and population begin to more spend,
which helps following development of European region and economy growth. Pawera et al (2015)
Inflation in Eurozone is much lower than 2% in the long term. Thus, the Governing Council adopted the
decision to reduce interest rates determined by the ECB e.g. marginal lending facility, main refinancing
operations and the deposit facility, in summer of 2014. Money market will function correctly, if sufficient
margin is between mentioned rates. Because the deposit facility rate had been close to 0 % before the
decision of the Governing Council and main refinancing operations had been around 0.25 %, after the
decrease of marginal lending facility to 0.15 %, the deposit facility decreased to minus 0.1 %. European
Central Bank (2014)
Since the mid of 2014, commercial banks on the European interbank market have hold their excess
deposits at the central bank for negative interest rates more frequently. Meanwhile, negative interest rates
have extended to other interbank market operations such as EONIA (Euro Overnight Index Average) or
EURIBOR (Euro Interbank Offered Rate), which are used for the valuation of financial products such as
bond with variable coupon or derivatives.

Fig 1 1 month, 3 month and 12 month interest rates of EURIBOR
Historically, the negative interest rates were a rare phenomenon. Nowadays, economic crisis and
investors' desire to safely store their assets rather than their consumption have signed under their
existence. In Europe, this phenomenon is typical for interbank market, where the main reason for negative
interest rate is the aim to decrease holding excess deposits at the central bank by commercial banks.
European central bank is trying to reduce excess liquidity from commercial banks thanks to negative
interest rates. Paškrtová and Stoličná (2014) They are also trying to encourage commercial banks to
further distribute excess liquidity in form of loans to non-financial entities.
In Denmark, negative interest rates have not occurred only in the interbank market, but also in the
commercial banking sector. Some commercial banks started to charge negative interest deposits and
mortgages of selected clients. Except Denmark, the negative interest rates have been introduced also in
other European countries such as Sweden or Switzerland. National Bank of Slovakia (2013)
The Aim of the Article
The aim of the research is to interpret the concept of negative interest. Because of the interpretation of
this term is ambiguous and there are multiple views on it, the task of this article is to highlight the
differences in the interpretations arising from the international accounting standard IFRS. The outcomes
of this research are formulating recommendations useful for further research of this topic and analysis of
influence of negative interest rates on the accounting in accordance with the international accounting
standard IFRS.
Methodology
The issue of negative interest rates hasn’t been fully known yet. This is the reason, why it was necessary
to define basic terms from the perspective of authors and from that of international accounting standard
IFRS as well. Examining the issue was carried out by the means of analysis of international accounting
standards and IFRS Interpretations Committee Meeting staff papers.

Current Interpretation of Negative Interest
Negative interest rate is not an issue, which is typical only for financial sector. In a period of very low
inflation and consumption, this issue has the potential to affect the deposits and loans of ordinary
population. The phenomenon of negative interest rates affects different departments of companies, such
as the risk management, payable and accounting.
For a proper understanding of their impact on record interest in accounting, it is necessary to correctly
interpret the term of negative interest rates and logically classify it.
"The assets of an entity are a result of past events which increase economic benefits of an entity in the
future and can be reliably recognized in the financial statements on the balance sheet." Olvecká (2014)
Conversely, the liabilities of an entity are a result of past events which decrease economic benefits of an
entity in the future. Mariak (2014) “The Act on Accounting 431/2002 in Slovakia defines revenues as
increases in economic benefits during an entity's financial year, which can be measured reliably."
Kajanová (2014)
According to IAS 18, revenues include those activities that result in the gross inflow of economic benefits
(cash, receivables, other assets) arising from the ordinary operating activities of an entity (such as sales of
goods, sales of services, interest, royalties, and dividends).
Positive interest rate arising from assets (e.g. from the provided deposit) is therefore considered as
income, because these operations increase the economic benefit of the entity. The lender receives income
from its capital which is lent to the debtor. If it is an interest arising from liabilities (e.g. received loan)
that reduce the economic benefits of an entity, we will consider the interest as an expense. International
Accounting Standards (2009)
Since the interest, a lender bank pays for its assets corresponds to the interest a borrower bank receives
for its liabilities, it is not necessary to analyze the emerging interest (positive or negative) in the assets
and liabilities separately.
There is not quite obvious economic explanation for the negative interest phenomenon and the description
of entire transmission mechanism in the economy is not very clear. The basic interpretation of negative
interest sees it as custodian fee for safeguarding the holder’s money, which lender pays the debtor.
International Accounting Standards (2014) Next explanation of the negative interest concept may be seen
from the perspective of the taxation of savings. Ifhannoun (2015) The income of a saver, who is unable to
spend it over a certain time period, will be cut by tax corresponding to a negative interest rate.
Different interpretations of the phenomenon raise questions concerning the possibility of presenting a
negative rate in the income statement. Their existence is not defined by any adjustment under IFRS. Due
to this situation, in September 2012 and January 2013 there were IFRS Interpretations Committee
Meetings. One of the peripheral issues discussed there was also negative interest arising from financial
assets.
Conclusions of IFRS Interpretations Committee were:
a) Interest on a financial asset does not fit the definition of interest yield in IAS 18
Revenue because it reflects a gross outflow, instead of a gross inflow of economic
benefits.
b) Interest on a financial assets cannot be regarded as interest expenses because interest
expenses can arise only from the financial liabilities of the entity. But it can be fit some
other appropriate expense classification. For example fee for custody. IFRS
Interpretations Committee Meeting (2013)

Since the IFRS Interpretations Committee considered further defining of negative interest unnecessary in
2013, it was not involved in agenda for next meetings.
Gaps in Current Interpretation of Negative Interest
To interpret negative interest as other expenses or as expenses for safekeeping, is economically
understandable for customers’ deposits in commercial banks or commercial banks’ excess liquidity
deposit to the central bank.
Clarity of interpretation of negative interest begins to fade at the moment of their application to other
financial products than deposits. In case of high-quality government bond with a floating three-month
coupon bound to interest rates EURIBOR with a negative risk premium, the following situation may
arise:
a) In case of buying such bond at the beginning of 2014 with an interest rate fixation from
January of 2014 to January of 2015, and without a risk premium, these coupons would
acquire a positive value. Accrued interest from this coupon would be classified as
revenue (period 0 to 1.25 at figure 2.).
b) In the fixed interest rate environment of three-month EURIBOR in April of 2015, this
coupon would acquire a negative value. Accrued interest from this coupon would
consequently be accounted as other expense, eventually as custody fee (period 1.5,
figure 2).
Fig 2 Floating rate bond cash flow
Cash flows from the assets held this way would consist of two main parts, namely interest yield and
custodian fees (expenses). Each of these financial flows would arise in different periods.
Purchased bond would accumulate an interest yield in the first quarter. But in the second quarter, the
coupon of the same bond would be considered as custody fee. Considering negative interest as fee for
custody or eventually as other expenses is confusing, since in both cases, the coupon has the same origin.

The second gap occurs in evidence of these expenses as custodian fees, because in case of debt securities,
this operation is unclear, as opposed to provided deposits.
Officials of KPMG and Deloitte pointed out similar shortcomings in interpretation of negative interest
IFRS Interpretations Committee. They see a major gap in recording negative interest as decided by the
Committee in 2013. This recording is distorting and insufficiently intuitive. The basic arguments were
expressed by KPMG as follows:
a) The interest yield of a financial asset can contain several components, some of which
can be negative,
b) Interest cash flows with a negative yield component or even a total negative yield, are,
intuitively and economically, still considered a part of (net) interest income,
c) Interest cash flows from a financial asset can be negative as a temporary and
exceptional phenomenon – but are still interest yield,
d) Adding positive to negative yield components of the same origin (same instrument) is
not a matter of offsetting but of aggregation. IFRS Interpretations Committee Meeting
(2013)
Based also on these objections, the IFRS Interpretations Committee decided to re-include the issue of
negative interest to its agenda in January 2015. The IFRS Interpretations Committee insists on the
classification, which classifies negative interest of financial assets among other expenses or fees for
safekeeping, because the current definition of revenues by IAS cannot include it to the interest yield (does
not increase the economic benefits of financial assets) as well as to the interest expense (which may be
formed only on financial liabilities). IFRS Interpretations Committee Meeting (2015)
Although the committee did not place solving the uncertainties of negative interest among its priorities,
the final report of the meeting held in January 2015 includes the possibility of further analysis of the
issue.
Thanks to the reformulation of the definition of revenues in IAS18, it would be possible to look at
negative interest on financial assets as a negative yield. This solution would bring clarity as possible
records negative interest in the IFRS accounts because now, the entities could reported negative interest
only as other expenses or as fee for custody. In case of assets the interest rate of which is bound to the
interest rate of the interbank market, the financial flows of these assets should always have two
components: interest yield and expense for the custody, which would need to be recorded separately. If
negative interest is classified as revenue, it would enable to record positive as well as negative interest
produced by financial assets clearer.
Conclusion
The Financial Times estimated the value of assets with negative interest rate by 8 January 2015 in
Europe, at about EUR 1.2 billion and according to JPMorgan it is EUR 1.5 billion. Clinch (2015)
If the inflation rate in Europe does not increase in the near future, it is very likely that such interest will be
more common, and that negative interest rates will occur in the interbank market and commercial banking
very frequently. That is the reason why it is needed to further analyze the issue of negative interest rate
and to clearly define its meaning and interpretation. This interpretation should not be purposeless, but
should be helping in other related fields such as risk management, reporting or accounting.
An unclear interpretation of the negative interest on one hand and a strict definition of other terms on the
other hand make it complicated to properly record negative interest in accounting. Current approach to
the phenomenon of negative interest that understands it as an expense different from interest expense has

still gaps which are needed to be fixed. The IFRS Interpretations Committee should take into
consideration claims of big audit and accounting firms and consider a redefinition of terms in
international accounting standards, so they would be adaptable to the situation in economy.
When the ECB has reduced the interest rate of deposit facilities to 0 % in 2014, it was a signal to financial
institutions that they should implement negative interest into their accounting systems. Since later
interpretation of terms from this field can make the expenses for such implementation expensive, it is
needed to address this issue.
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