July 14, 2017

BCBS published a working paper on the interplay of accounting and regulation and its impact of bank behavior. The paper focuses on identifying ways in which the interaction between accounting and regulatory rules provides incentives that affect the risk taking of financial institutions and on specific aspects of loan-loss provisioning, disclosure rules, fair value accounting, and prudential filters.

The results described in this paper as well as the conclusions from other studies suggest that both in the context of loan-loss provisioning and the valuation of bank assets, there is a tension between backward-looking and forward-looking measurement. This observation is also consistent with the mixed picture that is given by the analytical results regarding several research questions. One conclusion is that corner solutions in one or the other direction do not seem optimal, and that an adequate mix of the two concepts may be superior. The other conclusion is that further evidence on the research questions posed is clearly needed. For example, all projects of the work stream focus on quantities, but not on prices of financial instruments (for example, loan rates or yields of securities). Therefore, researchers are encouraged to further address the interplay of accounting and regulation and its impact on bank behavior from an academic perspective.

 

The Research Task Force of Basel Committee, in March 2013, initiated a work stream that deals with aspects of the interplay of accounting and regulation and its impact on bank behavior from a research perspective. Accounting rules and disclosure standards are important determinants for bank incentives and behavior; the recent financial crisis, where criticism was voiced (on the role of fair value accounting of financial assets and incurred loss provisioning of loans), is just another example of the importance and relevance of the financial reporting of banks in a regulatory and supervisory context.

 

Related Link: Working Paper (PDF)

Keywords: International, Banking, Accounting, Loan Loss Provisioning, Disclosure, Fair Value Accounting, BCBS