Fair value accounting: villain or innocent victim?: exploring the links between fair value accounting, bank regulatory capital, and the recent financial crisis
AbstractThere is a popular belief that the confluence of bank capital rules and fair value accounting helped trigger the recent financial crisis. The claim is that questionable valuations of long term investments based on prices obtained from illiquid markets created a pro-cyclical effect whereby mark to market adjustments reduced regulatory capital forcing banks to sell off investments which further depressed prices. This ultimately led to bank instability and the credit effects that reached a peak late in 2008. This paper analyzes a sample of large banks to attempt to measure the strength of the link between fair value accounting, regulatory capital rules, pro-cyclicality and financial contagion. The focus is on large banks because they value a significant portion of their balance sheets using fair value. They also hold investment portfolios that contain illiquid assets in large enough volumes to possibly affect the market in a pro-cyclical fashion. The analysis is based on a review of recent historical financial data. The analysis does not reveal a clear link for most banks in the sample, but rather suggests that there may have been other more significant factors putting stress on bank regulatory capital.
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Bibliographic InfoPaper provided by Federal Reserve Bank of Boston in its series Risk and Policy Analysis Unit Working Paper with number QAU10-1.
Date of creation: 2010
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ACC-2010-05-15 (Accounting & Auditing)
- NEP-ALL-2010-05-15 (All new papers)
- NEP-BAN-2010-05-15 (Banking)
- NEP-BEC-2010-05-15 (Business Economics)
- NEP-HIS-2010-05-15 (Business, Economic & Financial History)
- NEP-REG-2010-05-15 (Regulation)
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- Blakespoor, Elizabeth & Linsmeier, Thomas J. & Petroni, Kathy & Shakespeare, Catherine, 2012. "Fair Value Accounting for Financial Instruments: Does It Improve the Association between Bank Leverage and Credit Risk?," Research Papers 2107, Stanford University, Graduate School of Business.
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