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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.
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.
The recent financial crisis has led to a major debate about fair-value accounting. Many critics have argued that fair-value accounting, often also called mark-to-market accounting, has significantly contributed to the financial crisis or, at least, exacerbated its severity. In this paper, we assess these arguments and examine the role of fair-value accounting in the financial crisis using descriptive data and empirical evidence. Based on our analysis, it is unlikely that fair-value accounting added to the severity of the current financial crisis in a major way. While there may have been downward spirals or asset-fire sales in certain markets, we find little evidence that these effects are the result of fair-value accounting. We also find little support for claims that fair-value accounting leads to excessive write-downs of banks’ assets. If anything, empirical evidence to date points in the opposite direction, that is, towards overvaluation of bank assets.
The aim of this paper is to examine what has been the role of information provision to the market throughout the crisis. We consider two main sources of information to the market, financial statements and information provided by credit rating agencies. We examine how these sources of information work and the effectiveness of their disclosure process during the crisis. Contrary to the commonly held view, fair value accounting did not have a major impact on the crisis development and severity. However, the structure and lack of accountability of credit rating agencies had a profound impact on their incentives, which may have jeopardized the accuracy of the whole rating process. We claim that the crisis experience has changed the way we think about information as well as market discipline and discuss policy implications and proposals for regulation. JEL Classification: G01, G24, G28, M41, M48
When the COVID-19 crisis struck, banks using internal-rating based (IRB) models quickly recognized the increase in risk and reduced lending more than banks using a standardized approach. This effect is not driven by borrowers’ quality or by banks in countries with credit booms before the pandemic. The higher risk sensitivity of IRB models does not always result in lower credit provision when risk intensifies. Certain features of the IRB models – the use of a downturn Loss Given Default parameter – can increase banks’ resilience and preserve their intermediation capacity also during downturns. Affected borrowers were not able to fully insulate and decreased corporate investments.
The recent financial crisis has led to a vigorous debate about the pros and cons of fair-value accounting (FVA). This debate presents a major challenge for FVA going forward and standard setters’ push to extend FVA into other areas. In this article, we highlight four important issues as an attempt to make sense of the debate. First, much of the controversy results from confusion about what is new and different about FVA. Second, while there are legitimate concerns about marking to market (or pure FVA) in times of financial crisis, it is less clear that these problems apply to FVA as stipulated by the accounting standards, be it IFRS or U.S. GAAP. Third, historical cost accounting (HCA) is unlikely to be the remedy. There are a number of concerns about HCA as well and these problems could be larger than those with FVA. Fourth, although it is difficult to fault the FVA standards per se, implementation issues are a potential concern, especially with respect to litigation. Finally, we identify several avenues for future research. JEL Classification: G14, G15, G30, K22, M41, M42
There is much discussion today about a possible digital euro (PDE). Is this attention exaggerated? Are “central bank digital currencies” (CBDCs) “a solution in search of a problem”, as some have argued? This article summarizes the main facts about the PDE and concludes that, if the decision on adoption had to be taken today, the arguments against would outweigh those in favor. However, there may be future circumstances in which having a CBDC ready for use can indeed be useful. Therefore, preparing is a good thing, even if the odds of its usefulness in normal conditions are slim.