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Accounting, prudential regulation and financial stability: elements of a synthesis

  • Claudio E. V. Borio
  • Kostas Tsatsaronis

What information about the financial condition of firms is conducive to efficient and stable operation of the financial system and of the economy more broadly? In this essay, we outline the contours of an ideal set of such information, identify existing gaps and propose a way forward to fill them. We argue that an ideal set should comprise two dimensions. As regards financial characteristics, it should cover three different types, viz: estimates of the current financial condition ("first-moment information"); estimates of risk profiles ("risk information"); and measures of the uncertainty surrounding both kinds of estimate ("measurement error information"). As regards the object of the analysis, it should cover information about both the individual firm ("micro information") and, suitably aggregated, the "system" as a whole ("macro information"). So far, efforts have mainly focused on micro information and, within it, on estimates of the current financial condition; by contrast, risk information has drawn attention only more recently and measurement error information has been largely neglected. We also note that, as regards micro information, significant differences in perspective between accounting standard setters and prudential supervisors have come to light. We examine the reasons for these differences and propose ways in which they could be reconciled. We propose a strategy based on two principles: first, in the long term, the "decoupling" of the objective of accurate financial reporting about the firm from that of instilling the desired degree of prudence in its behaviour; and second, a "parallel" process towards that objective so that at all points the prudential authorities can neutralise any undesirable implications for financial stability of changes in financial reporting standards. We stress that close cooperation between accounting standard setters and supervisory authorities is called for both in developing the final set of information and in implementing it.

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Paper provided by Bank for International Settlements in its series BIS Working Papers with number 180.

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Length: 38 pages
Date of creation: Sep 2005
Date of revision:
Handle: RePEc:bis:biswps:180
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  1. Jon Danielsson & Hyun Song Shin & Jean-Pierre Zigrand, 2004. "The impact of risk regulation on price dynamics," LSE Research Online Documents on Economics 16628, London School of Economics and Political Science, LSE Library.
  2. Jeffery D Amato & Jacob Gyntelberg, 2005. "CDS index tranches and the pricing of credit risk correlations," BIS Quarterly Review, Bank for International Settlements, March.
  3. Charles Goodhart & Pojanart Sunirand & Dimitrios P. Tsomocos, 2004. "A time series analysis of financial fragility in the UK banking system," LSE Research Online Documents on Economics 24778, London School of Economics and Political Science, LSE Library.
  4. Graham, John R. & Harvey, Campbell R. & Rajgopal, Shiva, 2005. "The economic implications of corporate financial reporting," Journal of Accounting and Economics, Elsevier, vol. 40(1-3), pages 3-73, December.
  5. Helmut Elsinger & Alfred Lehar & Martin Summer, 2002. "Risk Assessment for Banking Systems," Working Papers 79, Oesterreichische Nationalbank (Austrian Central Bank).
  6. Hirshleifer, David & Teoh, Siew Hong, 2003. "Limited attention, information disclosure, and financial reporting," Journal of Accounting and Economics, Elsevier, vol. 36(1-3), pages 337-386, December.
  7. Upper, Christian & Worms, Andreas, 2004. "Estimating bilateral exposures in the German interbank market: Is there a danger of contagion?," European Economic Review, Elsevier, vol. 48(4), pages 827-849, August.
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