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Fair value accounting (FVA) refers to the practice of updating the valuation of assets or securities on a regular basis, ideally by reference to current prices for similar assets or securities established in the context of a liquid market; historical cost accounting (HCA) instead records the value of an asset as the price at which it was originally purchased. In the wake of the 2008 financial crisis, conflicting arguments have been made about the contributions of valuation approaches in triggering the crisis. This report investigates and clarifies the relationship between these two accounting approaches and risks to the financial system. The authors examine the risk implications of FVA and HCA in the various situations in which each is used; assess the role that these accounting approaches have played historically in financial crises, including the 2008 financial crisis, the savings and loan crisis of the 1980s, and the less developed country debt crisis of the 1970s; and explore insights about systemic risk that can be gleaned from better understanding the accounting approaches. The authors find that FVA was probably not a primary driver of the 2008 crisis. Moreover, they suggest that neither FVA nor HCA is objectively ⁰[MARC+62][MARC+65][MARC+74][MARC+74][MARC+65][MARC+72]⁰₊ than the other. Instead, both accounting approaches can provide useful information for different contexts when applied rigorously, but when they are implemented poorly or when regulatory oversight is weak, both FVA and HCA can produce misleading information that can increase systemic risk across the financial sector. The authors conclude with a series of recommendations for how FVA and HCA, and the financial information that both methods generate, can be improved to better protect against systemic risk to the banking sector in the future.
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In light of the uncertainties about valuation highlighted by the 2007-2008 market turbulence, this paper provides an empirical examination of the potential procyclicality that fair value accounting (FVA) could introduce in bank balance sheets. The paper finds that, while weaknesses in the FVA methodology may introduce unintended procyclicality, it is still the preferred framework for financial institutions. It concludes that capital buffers, forward-looking provisioning, and more refined disclosures can mitigate the procyclicality of FVA. Going forward, the valuation approaches for accounting, prudential measures, and risk management need to be reconciled and will require adjustments on the part of all parties.
Commerce --- Business & Economics --- Accounting --- Business cycles. --- Fair value --- Accounting. --- Economic cycles --- Economic fluctuations --- Cycles --- Banks and Banking --- Finance: General --- Investments: General --- Macroeconomics --- Industries: Financial Services --- Financial Markets and the Macroeconomy --- Financial Institutions and Services: Government Policy and Regulation --- Public Administration --- Public Sector Accounting and Audits --- Banks --- Depository Institutions --- Micro Finance Institutions --- Mortgages --- Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data) --- General Financial Markets: General (includes Measurement and Data) --- Pension Funds --- Non-bank Financial Institutions --- Financial Instruments --- Institutional Investors --- Financial reporting, financial statements --- Banking --- Economic growth --- Investment & securities --- Finance --- Financial statements --- Business cycles --- Securities --- Financial instruments --- Public financial management (PFM) --- Financial institutions --- Loans --- Finance, Public --- Banks and banking --- United States
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