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Financial Stability Paper 31: Understanding the fair value of banks’ loans

Author

Listed:
  • Knott, Samuel

    (Bank of England)

  • Richardson, Peter

    (Bank of England)

  • Rismanchi, Katie

    (Bank of England)

  • Sen, Kallol

    (Bank of England)

Abstract

​Loans are typically the largest asset class on banks’ balance sheets. So understanding the value of loans is vital to any assessment of the resilience of the banking system. This is not straightforward. The market value of loans is seldom observable. And the nature and diversity of banks’ loans has changed markedly over time: the maturity of loans has increased, on average; banks’ mortgage lending has ballooned; and banks use more hard information in their lending decisions. So it is unlikely that any one valuation technique will capture all relevant aspects of valuation across all types of loans. Recognising this, banks are required by accounting standards to disclose the fair value of their loans in the notes to their accounts. At the end of 2013, the fair value of the major UK banks’ loans was £55 billion less than the amortised cost value. This paper explains loan fair value techniques and compares these to other valuation approaches. Fair value approaches include elements of valuation that are not captured by amortised cost approaches, such as lifetime expected credit losses and embedded interest rate gains and losses. As such, fair value disclosures might provide additional insight into the value of some assets, such as longer-term, fixed-rate loans, like mortgages. But loan fair values, like all loan valuation approaches, come with a number of health warnings. For example, they may capture factors that do not necessarily have a bearing on banks’ resilience. As a result, a loan fair value number on its own is often insufficient, which suggests that there may be benefits to improved supplementary disclosures about the drivers of the fair value of banks’ loans to complement balance sheet values.

Suggested Citation

  • Knott, Samuel & Richardson, Peter & Rismanchi, Katie & Sen, Kallol, 2014. "Financial Stability Paper 31: Understanding the fair value of banks’ loans," Bank of England Financial Stability Papers 31, Bank of England.
  • Handle: RePEc:boe:finsta:0031
    Note: http://www.bankofengland.co.uk/financialstability/Pages/fpc/fspapers/fs_paper31.aspx
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    References listed on IDEAS

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    Keywords

    bank regulation; fair value;

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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