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Accounting Discretion of Banks During a Financial Crisis

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  • Huizinga, H.P.
  • Laeven, L.

    (Tilburg University, Center for Economic Research)

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 Tilburg University, Center for Economic Research in its series Discussion Paper with number 2009-58.

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Date of creation: 2009
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Handle: RePEc:dgr:kubcen:200958

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Web page: http://center.uvt.nl

Related research

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

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Citations

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Cited by:
  1. Kollmann, Robert, 2012. "Global Banks, Financial Shocks and International Business Cycles: Evidence from an Estimated Model," CEPR Discussion Papers 8985, C.E.P.R. Discussion Papers.
  2. Kollmann, Robert & Zeugner, Stefan, 2011. "Leverage as a Predictor for Real Activity and Volatility," CEPR Discussion Papers 8327, C.E.P.R. Discussion Papers.
  3. Robert KOLLMANN, 2011. "Global Banking and International Business Cycles," 2011 Meeting Papers 20, Society for Economic Dynamics.
  4. Ceyla Pazarbasioglu & Luc Laeven & Oana M. Nedelescu & Stijn Claessens & Fabian Valencia & Marc Dobler & Katharine Seal, 2011. "Crisis Management and Resolution: Early Lessons from the Financial Crisis," IMF Staff Discussion Notes 11/05, International Monetary Fund.
  5. 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.
  6. Nicolas Veron, 2011. "Keeping the Promise of Global Accounting Standards," Policy Briefs PB11-11, Peterson Institute for International Economics.
  7. Luc Laeven, 2011. "Banking Crises: A Review," Annual Review of Financial Economics, Annual Reviews, vol. 3(1), pages 17-40, December.
  8. 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.
  9. Matej Marinc & Razvan Vlahu, 2011. "The Economic Perspective of Bank Bankruptcy Law," DNB Working Papers 310, Netherlands Central Bank, Research Department.

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