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04 June 2013

FT: Mark to market best to spot risky banks


An academic study, 'Fair Value Accounting for Financial Instruments: Does it Improve the Association Between Bank Leverage and Credit Risk?', has concluded that "mark to market" accounting is significantly more accurate than other accounting methods in predicting the risk of banks failing.

It could give fodder to proponents of “fair value” accounting, just as the FASB is working to finalise an accounting update that would reduce the role of mark to market rules.

The US accounting standards-setter rowed back on a plan proposed in 2010 to increase the use of mark to market, after lobbying from the financial services industry. Opponents say obliging banks to hold assets at their market value leads to wild swings in the value of balance sheets and might not reflect financial companies’ real risk of failure.

The four authors of the study focused on banks’ leverage ratios, which measure banks’ borrowing levels against their assets. They found leverage ratios tied to assets held at their market value were at least 25 per cent more accurate in explaining the credit risk of banks than the two other accounting methods currently embedded in US GAAP accounting rules.

"This evidence suggests that banks’ financial statements with financial instruments measured at fair values, including loans, deposits, debt, and held-to-maturity securities, are more descriptive of the credit risk inherent in the business model of banks than the current GAAP financial statements”, the paper concludes.

Full article (FT subscription required)

Study © Stanford University



© Financial Times


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