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Fair value accounting for financial instruments: some implications for bank regulation

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  • Wayne Landsman

    (University of North Carolina at Chapel Hill - Accounting Area)

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    Abstract

    I identify issues that bank regulators need to consider if fair value accounting is used for determining bank regulatory capital and when making regulatory decisions. In financial reporting, US and international accounting standard setters have issued several disclosure and measurement and recognition standards for financial instruments and all indications are that both standard setters will mandate recognition of all financial instruments at fair value. To help identify important issues for bank regulators, I briefly review capital market studies that examine the usefulness of fair value accounting to investors, and discuss marking-to-market implementation issues of determining financial instruments' fair values. In doing so, I identify several key issues. First, regulators need to consider how to let managers reveal private information in their fair value estimates while minimising strategic manipulation of model inputs to manage income and regulatory capital. Second, regulators need to consider how best to minimise measurement error in fair values to maximise their usefulness to investors and creditors when making investment decisions, and to ensure bank managers have incentives to select investments that maximise economic efficiency of the banking system. Third, cross-country institutional differences are likely to play an important role in determining the effectiveness of using mark-to-market accounting for financial reporting and bank regulation.

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    Bibliographic Info

    Paper provided by Bank for International Settlements in its series BIS Working Papers with number 209.

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    Length: 32 pages
    Date of creation: Aug 2006
    Date of revision:
    Handle: RePEc:bis:biswps:209

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    Keywords: fair values; financial instruments; information asymmetry;

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    1. Guillaume Plantin & Haresh Sapra & Hyun Shin, . "Marking to Market: Panacea or Pandora’s Box ?," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 2005-E4, Carnegie Mellon University, Tepper School of Business.
    2. Chava, Sudheer & Jarrow, Robert, 2008. "Modeling loan commitments," Finance Research Letters, Elsevier, Elsevier, vol. 5(1), pages 11-20, March.
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    Cited by:
    1. David VanHoose, 2007. "Market Discipline and Supervisory Discretion in Banking: Reinforcing or Conflicting Pillars of Basel II?," NFI Working Papers 2007-WP-06, Indiana State University, Scott College of Business, Networks Financial Institute.
    2. Laux, Christian & Leuz, Christian, 2009. "The crisis of fair value accounting: Making sense of the recent debate," CFS Working Paper Series 2009/09, Center for Financial Studies (CFS).
    3. Heaton, John C. & Lucas, Deborah & McDonald, Robert L., 2010. "Is mark-to-market accounting destabilizing? Analysis and implications for policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 57(1), pages 64-75, January.

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