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Accounting Discretion of Banks During a Financial Crisis

  • Luc Laeven
  • Harry Huizinga

This paper shows that banks use accounting discretion to overstate the value of distressed assets. Banks' balance sheets overvalue real estate-related assets compared to the market value of these assets, especially during the U.S. mortgage crisis. Share prices of banks with large exposure to mortgage-backed securities also react favorably to recent changes in accounting rules that relax fair-value accounting, and these banks provision less for bad loans. Furthermore, distressed banks use discretion in the classification of mortgage-backed securities to inflate their books. Our results indicate that banks' balance sheets offer a distorted view of the financial health of the banks.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 09/207.

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Length: 41
Date of creation: 01 Sep 2009
Date of revision:
Handle: RePEc:imf:imfwpa:09/207
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