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Evaluating the impact of fair value accounting on financial institutions: implications for accounting standards setting and bank supervision

  • Sanders Shaffer
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    Recent standard-setting activity related to fair value accounting has injected new life into questions of whether fair value provides information useful for decision-making, and whether there might be unintended consequences on financial stability. This discussion paper provides insight into these questions by performing a holistic evaluation of fair value accounting’s usefulness, the potential impacts it may have on financial institutions and any broader macroeconomic effects. Materials reviewed as part of this analysis include public bank regulatory filings, financial statements, and fair value research. The bank supervisory rating approach referred to as CAMELS is used as an organizing principle for the paper. CAMELS serves as a convenient way to both categorize potential impacts of fair value on financial institutions, as well as provide a bank supervisory perspective alongside the more traditional investor’s views on decision usefulness. ; The overall conclusion based on the evidence presented is that implementing fair value accounting more broadly may not necessarily provide financial statement users with more transparent and useful reporting. Additionally, financial stability may be negatively impacted by fair value accounting due to the interconnectedness of financial institutions, markets and the broader economy. The analysis suggests that the current direction in which accounting standard setters and bank regulators are moving may represent a possible solution to address these concerns. U.S. accounting standard setters have recently proposed that fair value, along with enhanced disclosures, be applied in a more targeted manner. Bank regulators are developing new supervisory tools and approaches which may alleviate some of the potential negative impact of fair value on financial stability. Additional policy implications and areas for future study are suggested.

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    Paper provided by Federal Reserve Bank of Boston in its series Risk and Policy Analysis Unit Working Paper with number QAU12-1.

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    Date of creation: 2012
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    Handle: RePEc:fip:fedbqu:qau12-1
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    1. Benston, George J., 2006. "Fair-value accounting: A cautionary tale from Enron," Journal of Accounting and Public Policy, Elsevier, vol. 25(4), pages 465-484.
    2. Eccher, Elizabeth A. & Ramesh, K. & Thiagarajan, S. Ramu, 1996. "Fair value disclosures by bank holding companies," Journal of Accounting and Economics, Elsevier, vol. 22(1-3), pages 79-117, October.
    3. Allen, Franklin & Carletti, Elena, 2008. "Mark-to-market accounting and liquidity pricing," Journal of Accounting and Economics, Elsevier, vol. 45(2-3), pages 358-378, August.
    4. Guillaume Plantin & Haresh Sapra & Hyun Shin, . "Marking to Market: Panacea or Pandora’s Box ?," GSIA Working Papers 2005-E4, Carnegie Mellon University, Tepper School of Business.
    5. Coles, Jeffrey L. & Daniel, Naveen D. & Naveen, Lalitha, 2006. "Managerial incentives and risk-taking," Journal of Financial Economics, Elsevier, vol. 79(2), pages 431-468, February.
    6. Livne, Gilad & Markarian, Garen & Mironov, Maxim, 2013. "Investment horizon, risk, and compensation in the banking industry," Journal of Banking & Finance, Elsevier, vol. 37(9), pages 3669-3680.
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