The National Bank of Ethiopia (NBE) ordered financial institutions to stop recognising gains from fixed asset valuation, including buildings, as paid-up capital.

Issued on October 8, 2019, the circular signed by Tirunh Mitafa, the outgoing vice governor of the Bank, ordered all of the banks and insurance companies to hold the gains obtained as a result of asset valuations in retained earning accounts until further direction is issued.

After the adoption of the International Financial Reporting Standards (IFRS), a set of accounting standards that provide a common global language for business activities, the financial institutions have begun valuing assets against the current market price. Previously, assets and liabilities have been recorded on their accounting records as a historical cost, aka the original cost. As a standard, IFRS requires banks and insurance companies to conduct a valuation of their assets and liabilities.

Starting from last year, while preparing financial reports, the banks and insurance companies are valuing their assets and liabilities against current market prices. They also add the gains from the properties into paid-up capital after paying taxes.

“This practice may not be prudent as the revaluation gains are being distributed to shareholders before the realisations of the gains,” reads the letter from the central bank.

The latest circular followed a letter that was issued two weeks ago informing the financial institutions to halt the submission of their audited financial reports. Dispatched on October 1, 2019, the letter indicated that the central bank had requested an explanation from the Accounting & Auditing Board of Ethiopia (AABE) on how the revaluation gains should be treated.

“This [revaluation gains] needs caution as the approach may not be valid in a review of the safety and soundness of the institutions,” reads the letter from the central bank.

After discussing with the Board, the NBE ordered the financial institutions to keep the gains in a retained earning account - where profits are retained before dividends are paid since the amount could be subjected to adjustment - until another direction is issued.

The Board has been informing all the financial institutions and the central bank to be cautious on the issue, according to a senior official from the Board, who requested anonymity.

"Capitalising gains that are not held in cash has a risk," said the official. "It could cause a crisis in the institutions as well as the overall economy."