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Accounting discretion of banks during a financial crisis

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  • Huizinga, Harry
  • Laeven, Luc

Abstract

This paper presents evidence of banks using accounting discretion to overstate the value of distressed assets. In particular, we show that the stock market applies far greater discounts to a bank’s real estate loans and mortgage-backed securities than are implicit in the book values of these assets, especially following the onset of the U.S. mortgage crisis. This suggests that bank balance sheets overvalue real estate related assets during economic slowdowns. Estimated discounts are smaller for distressed banks, as these banks derive relatively large benefits from the financial safety net to offset asset impairment. We also find that bank share prices, especially for banks with large exposures to mortgage-backed securities, react favorably to recent changes in accounting rules that relax fair value accounting. Banks with large exposures to mortgage-backed securities are also found to provision less for bad loans. Finally, we find that banks, and especially distressed banks, use discretion in the classification of mortgage-backed securities so as to inflate the book value of these securities. Our results provide several pieces of compelling evidence that banks’ balance sheets offer a distorted view of the financial health of the banks, especially for banks with large exposures to real estate loans and mortgage-backed securities, and suggest that recent changes that relax fair value accounting may further distort this picture.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7381.

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Date of creation: Jul 2009
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Handle: RePEc:cpr:ceprdp:7381

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Keywords: accounting standards; bank regulation; fair value accounting; financial crisis; mortgage-backed securities; real estate loans;

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References

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Citations

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Cited by:
  1. Ceyla Pazarbasioglu & Luc Laeven & Oana M. Nedelescu & Stijn Claessens & Fabian Valencia & Marc Dobler & Katharine Seal, 2011. "Crisis Management and Resolution," IMF Staff Discussion Notes 11/05, International Monetary Fund.
  2. Matej Marinc & Razvan Vlahu, 2011. "The Economic Perspective of Bank Bankruptcy Law," DNB Working Papers 310, Netherlands Central Bank, Research Department.
  3. Kollmann, Robert & Enders, Zeno & Müller, Gernot J., 2011. "Global banking and international business cycles," European Economic Review, Elsevier, vol. 55(3), pages 407-426, April.
  4. Robert Kollmann & Stefan Zeugner, 2011. "Leverage as a Predictor for Real Activity and Volatility," Working Papers ECARES ECARES 2011-009, ULB -- Universite Libre de Bruxelles.
  5. European Commission, 2010. "Tax Policy after the Crisis: Monitoring Tax Revenues and Tax Reforms in EU Member States 2010 Report," Taxation Papers 24, Directorate General Taxation and Customs Union, European Commission.
  6. Robert Kollmann, 2013. "Global Banks, Financial Shocks And International Business Cycles: Evidence From An Estimated Model," CAMA Working Papers 2013-30, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  7. Sachverständigenrat zur Begutachtung der Gesamtwirtschaftlichen Entwicklung (ed.), 2012. "Nach dem EU-Gipfel: Zeit für langfristige Lösungen nutzen," Special Reports / Sondergutachten, German Council of Economic Experts / Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung, number 75379.
  8. Luc Laeven, 2011. "Banking Crises: A Review," Annual Review of Financial Economics, Annual Reviews, vol. 3(1), pages 17-40, December.
  9. Nicolas Veron, 2011. "Keeping the Promise of Global Accounting Standards," Policy Briefs PB11-11, Peterson Institute for International Economics.

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