Fair value levels in bank accounts

Trading books, derivative portfolios and investment securities are measured at fair value, and readers want to know how much of that value comes from market prices and how much from the bank's own models. This guide explains the three levels with typical banking examples, valuation adjustments, the rule on day one profits, and what banks disclose.

By Mirza Fahad Baig, Chartered Accountant. Reviewed by Hamza Fida, Chartered Accountant. 3 minute read.

Short answer

The fair value hierarchy in IFRS 13 classifies a bank's fair value measurements by the inputs used. Level 1 uses quoted prices in active markets for identical instruments, such as listed shares and government bonds. Level 2 uses other observable inputs, such as yield curves for interest rate swaps. Level 3 uses significant unobservable inputs, such as private equity stakes and long-dated or exotic derivatives. Banks disclose amounts in each level, and Level 3 carries the most disclosure, because the bank's own models drive the value. Day one profits on Level 3 instruments are deferred.

At a glance

Level 1
Quoted prices, identical instruments
Level 2
Other observable inputs
Level 3
Significant unobservable inputs
Day one profit
Deferred unless inputs observable
Adjustments
CVA, DVA, FVA, bid-offer
Disclosure
Most detail for Level 3
Fair value levels in bank accountsLevel 1: Quoted prices, identical instruments; Level 2: Other observable inputs; Level 3: Significant unobservable inputs; Day one profit: Deferred unless inputs observable; Adjustments: CVA, DVA, FVA, bid-offer; Disclosure: Most detail for Level 3.KEY FACTS AT A GLANCEFair value levels in bank accountsLevel 1Quoted prices, identicalinstrumentsLevel 2Other observable inputsLevel 3Significant unobservableinputsDay one profitDeferred unless inputsobservableAdjustmentsCVA, DVA, FVA, bid-offerDisclosureMost detail for Level 3Tax BakersFair value levels in bank accountsLevel 1: Quoted prices, identical instruments; Level 2: Other observable inputs; Level 3: Significant unobservable inputs; Day one profit: Deferred unless inputs observable; Adjustments: CVA, DVA, FVA, bid-offer; Disclosure: Most detail for Level 3.KEY FACTS AT A GLANCEFair value levels in bank accountsLevel 1Quoted prices, identical instrumentsLevel 2Other observable inputsLevel 3Significant unobservable inputsDay one profitDeferred unless inputs observableAdjustmentsCVA, DVA, FVA, bid-offerDisclosureMost detail for Level 3Tax Bakers
Key facts at a glance, as set out in this guide.

What goes into each level of the fair value hierarchy?

Typical bank instruments by levelTypical bank instruments by levelLevelMain inputListed shares,government bonds1Quoted priceInterest rateswaps2Yield curvesCorporate bonds,thinly traded2 or 3Comparable pricesExotic or long-dated derivatives3Correlation,volatilityPrivate equitystakes3Valuationmultiples
The more a value depends on the bank's own assumptions, the higher the level.

The level is set by the lowest-level input that is significant to the whole measurement. A swap valued from observable yield curves is Level 2; the same swap with a 30-year tenor beyond the observable curve may be Level 3 if the extrapolated part is significant.

An example: a day one gain

A bank sells a client a structured derivative for a premium of 1,000,000. Its valuation model, which relies on a correlation input that cannot be observed in the market, values the derivative at 950,000. The apparent day one profit of 50,000 cannot be recognised immediately, because fair value is not evidenced by an observable market price or a valuation using only observable data. The bank initially measures the derivative at the transaction price, 1,000,000, and recognises the 50,000 over the life of the trade, or earlier if the inputs become observable or the trade is closed out.

What valuation adjustments do banks make?

  • CVA, credit valuation adjustment: for the counterparty's credit risk on derivative assets.
  • DVA, debit valuation adjustment: for the bank's own credit risk on derivative liabilities.
  • FVA, funding valuation adjustment: for the cost of funding uncollateralised derivatives, applied by many banks.
  • Bid-offer and model uncertainty adjustments: to move mid-market model values to exit prices.

How do banks govern their valuations?

Through a valuation control function, usually in finance or risk and independent of the traders: independent price verification of model inputs against market data, review and approval of valuation models, and committees that agree valuation adjustments. The results feed both the accounts and the prudent valuation deduction from capital.

What causes transfers between levels?

Changes in market activity. A corporate bond whose market dries up in a stress period may move from Level 2 to Level 3 because comparable prices are no longer available, and back again when trading resumes. Banks disclose transfers and their policy for when transfers are deemed to occur.

What do banks disclose about Level 3?

  • A full reconciliation of opening to closing Level 3 balances, showing gains and losses, purchases, sales, settlements and transfers into and out of Level 3.
  • The valuation techniques and the significant unobservable inputs, with their ranges and averages.
  • The sensitivity of the fair value to reasonably possible changes in those inputs.
  • The deferred day one profits not yet recognised and their movements during the year.

Do loans at amortised cost need fair value disclosures?

Yes. IFRS 7 requires the fair value of financial instruments measured at amortised cost to be disclosed, with their level. For loans and deposits, fair values are usually Level 3, estimated by discounting cash flows at current rates for similar lending, and can differ markedly from carrying amounts when interest rates move.

How does fair value uncertainty affect capital?

Prudent valuation rules require banks to deduct from capital an amount reflecting the uncertainty in fair values, largest for Level 3 positions, so the same valuation judgements affect both profit and capital. See regulatory capital vs IFRS equity, bank accounting and offsetting and netting.

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Questions people ask

What is the fair value hierarchy?

The IFRS 13 classification of fair value measurements into Level 1 (quoted prices), Level 2 (other observable inputs) and Level 3 (significant unobservable inputs).

Which bank instruments are Level 3?

Instruments valued with significant unobservable inputs, such as exotic or long-dated derivatives, private equity stakes and illiquid loans.

Can banks recognise a day one gain on a derivative?

Only if fair value is evidenced by a quoted price or a valuation using only observable data; otherwise it is deferred.

What is CVA?

A credit valuation adjustment reducing the fair value of derivative assets for the counterparty's credit risk.

Sources

Every fee, date and rule on this page was taken from these official and primary sources.

  1. IFRS Foundation: IFRS 13 Fair Value Measurement

Rules and fees change. If you are reading this long after October 4, 2026, confirm the figures with the source before you rely on them.

BankingBank accounting: the key IFRS issuesBankingRegulatory capital vs IFRS equityBankingOffsetting and netting agreements

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This guide is general information. It is not tax or legal advice for your situation.