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Accounting for financial stability: Bank disclosure and loss recognition in the financial crisis
(2020)
This paper examines banks’ disclosures and loss recognition in the financial crisis and identifies several core issues for the link between accounting and financial stability. Our analysis suggests that, going into the financial crisis, banks’ disclosures about relevant risk exposures were relatively sparse. Such disclosures came later after major concerns about banks’ exposures had arisen in markets. Similarly, the recognition of loan losses was relatively slow and delayed relative to prevailing market expectations. Among the possible explanations for this evidence, our analysis suggests that banks’ reporting incentives played a key role, which has important implications for bank supervision and the new expected loss model for loan accounting. We also provide evidence that shielding regulatory capital from accounting losses through prudential filters can dampen banks’ incentives for corrective actions. Overall, our analysis reveals several important challenges if accounting and financial reporting are to contribute to financial stability.
This paper investigates what we can learn from the financial crisis about the link between accounting and financial stability. The picture that emerges ten years after the crisis is substantially different from the picture that dominated the accounting debate during and shortly after the crisis. Widespread claims about the role of fair-value (or mark-to-market) accounting in the crisis have been debunked. However, we identify several other core issues for the link between accounting and financial stability. Our analysis suggests that, going into the financial crisis, banks’ disclosures about relevant risk exposures were relatively sparse. Such disclosures came later after major concerns about banks’ exposures had arisen in markets. Similarly, banks delayed the recognition of loan losses. Banks’ incentives seem to drive this evidence, suggesting that reporting discretion and enforcement deserve careful consideration. In addition, bank regulation through its interlinkage with financial accounting may have dampened banks’ incentives for corrective actions. Our analysis illustrates that a number of serious challenges remain if accounting and financial reporting are to contribute to financial stability.
This chapter analyzes the role of financial accounting in the German financial system. It starts from the common perception that German accounting is rather "uninformative". This characterization is appropriate from the perspective of an arm´s length or outside investor and when confined to the financial statements per se. But it is no longer accurate when a broader perspective is adopted. The German accounting system exhibits several arrangements that privately communicate information to insiders, notably the supervisory board. Due to these features, the key financing and contracting parties seem reasonably well informed. The same cannot be said about outside investors relying primarily on public disclosure. A descriptive analysis of the main elements of the Germany system and a survey of extant empirical accounting research generally support these arguments.
Economic theory suggests that a commitment by a firm to increased levels of disclosure should lower the information asymmetry component of the firm’s cost of capital. But whi le the theory is compelling, so far empirical results relating increased levels of disclosure to measurable economic benefits have been mixed. One explanation for the mixed results among studies using data from firms publicly registered in the US is that, under current US reporting standards, the disclosure environment is already rich. In this paper, we study German firms that have switched from the German to an international reporting regime (IAS or US -GAAP), thereby committing themselves to increased le vels of disclosure. We show that proxies for the information asymmetry component of the cost of capital for the switching firms, namely the bid-ask spread and trading volume, behave in the predicted direction compared to firms employing the German reporti ng regime.
This paper investigates whether firms employing IAS or US GAAP exhibit measurable differences in proxies for information asymmetry and market liquidity. Sample firms are drawn from the "New Market" at the Frankfurt Stock Exchange. All firms listed in this market segment are required to provide financial statements in accordance with either IAS or US GAAP as part of the listing agreement. The sample choice provides a market-based comparison of the two standards holding disclosure requirements and standard enforcement constant. I find that differences in the bid-ask spread and trading volume are relatively small and more likely to be driven by firm characteristics than the choice of accounting standards. In contrast, New Market firms have lower spreads and higher turnover when compared with size-matched firms in other market segments following German GAAP. The results suggests that rigid disclosure regulation of the New Market matters in terms of information asymmetry and liquidity, but that the choice between IAS and US GAAP is of second order importance.
JEL Classification: D82, G30, M41
We investigate the impact of reporting regulation on corporate innovation. Exploiting thresholds in Europe’s regulation and a major enforcement reform in Germany, we find that forcing firms to publicly disclose their financial statements discourages innovative activities. Our evidence suggests that reporting regulation has significant real effects by imposing proprietary costs on innovative firms, which in turn diminish their incentives to innovate. At the industry level, positive information spillovers (e.g., to competitors, suppliers, and customers) appear insufficient to compensate the negative direct effect on the prevalence of innovative activity. The spillovers instead appear to concentrate innovation among a few large firms in a given industry. Thus, financial reporting regulation has important aggregate and distributional effects on corporate innovation.
We investigate the impact of reporting regulation on corporate innovation. Exploiting thresholds in Europe’s regulation and a major enforcement reform in Germany, we find that forcing firms to publicly disclose their financial statements discourages innovative activities. Our evidence suggests that reporting regulation has significant real effects by imposing proprietary costs on innovative firms, which in turn diminish their incentives to innovate. At the industry level, positive information spillovers (e.g., to competitors, suppliers, and customers) appear insufficient to compensate the negative direct effect on the prevalence of innovative activity. The spillovers instead appear to concentrate innovation among a few large firms in a given industry. Thus, financial reporting regulation has important aggregate and distributional effects on corporate innovation.