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Accounting Discretion of Banks During a Financial Crisis

Huizinga,H.P.
; 
Laeven,L.
Abstract
This paper presents evidence of banks using accounting discretion to overstate the value of distressed assets. In particular, we show that the stock market applies far greater discounts to a bank’s real estate loans and mortgage-backed securities than are implicit in the book values of these assets, especially following the onset of the U.S. mortgage crisis. This suggests that bank balance sheets overvalue real estate related assets during economic slowdowns. Estimated discounts are smaller for distressed banks, as these banks derive relatively large benefits from the financial safety net to offset asset impairment. We also find that bank share prices, especially for banks with large exposures to mortgage-backed securities, react favorably to recent changes in accounting rules that relax fair value accounting. Banks with large exposures to mortgage-backed securities are also found to provision less for bad loans. Finally, we find that banks, and especially distressed banks, use discretion in the classification of mortgage-backed securities so as to inflate the book value of these securities. Our results provide several pieces of compelling evidence that banks’ balance sheets offer a distorted view of the financial health of the banks, especially for banks with large exposures to real estate loans and mortgage-backed securities, and suggest that recent changes that relax fair value accounting may further distort this picture.
Description
This is also EBC Discussion Paper 2009-17 Pagination: 58
Date
2009
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Volume Title
Publisher
Finance
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Tilburg University Research Output Collection
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Keywords
bank regulation, accounting standards, fair value accounting, real estate loans, mortgage-backed securities, financial crisis, G14 - Information and Market Efficiency ; Event Studies ; Insider Trading, G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages, SDG 1 - No Poverty, SDG 8 - Decent Work and Economic Growth, SDG 10 - Reduced Inequalities
Citation
Huizinga, H P & Laeven, L 2009 'Accounting Discretion of Banks During a Financial Crisis' CentER Discussion Paper, vol. 2009-58, Finance, Tilburg.
URI
https://hdl.handle.net/20.500.14602/27970
License
info:eu-repo/semantics/restrictedAccess
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