How should banks account for loan losses?
The agencies that regulate banks are involved in an ongoing debate about the appropriate way for banks and other lenders to account for default risk on loans. Accounting authorities are concerned with whether the accounting method meets the needs of general-purpose users of financial statements, particularly investors. In contrast, bank supervisors are concerned about banks being inadequately capitalized and possibly failing. ; To shed light on this debate, this article reviews the generally accepted accounting principles (GAAP) currently used, which are based on historic-cost values for assets and liabilities. It then analyzes economic-value, or fair-value, accounting, which is being discussed as a substitute. ; The analysis suggests that the reported GAAP value is likely to understate the economic value of most banks’ portfolios most of the time. The economic values of loans would be more valuable if they were reliable. However, the authors argue, the fair value of credit losses must be estimated by management and hence may be biased by managerial attempts to attain earnings and capital targets. ; The authors conclude that using the lower of historic cost or economic value for valuing the credit risk of loans would provide the most relevant adequately reliable measure of loan value and would thus be the most appropriate procedure.
Volume (Year): (2005)
Issue (Month): Q4 ()
|Contact details of provider:|| Postal: |
Web page: http://www.frbatlanta.org/
More information through EDIRC
|Order Information:|| Email: |
When requesting a correction, please mention this item's handle: RePEc:fip:fedaer:y:2005:i:q4:p:19-38:n:v.90no.4. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Meredith Rector)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.