Can Accounting Rules Be Made Neutral for Bank Capital Regulation?

Abstract:     
This paper evaluates several methods which can possibly be used to minimize the pro-cyclical impact of accounting rules on bank capital regulation. Improving accounting rules cannot eliminate the pro-cyclicality problem as the recently proposed expected credit loss impairment model for historical cost accounting may be moving towards using information inputs for fair values. Limiting the trading activities accounted for by fair values may reduce the pro-cyclicality. However, it cannot eliminate the impact of fair values in a liquidity crisis. The most effective method is to exclude the unrealized accounting gains or losses from regulatory capital. But it needs a report of capital ratios based on accounting measures to help regulators read the early warning signals emitted by the accounting information.

Number of Pages in PDF File: 27

Keywords: Bank capital regulation, Leverage ratio, Tier 1 capital ratio, Fair value accounting, Historical cost accounting, Financial crisis, Pro-cyclicality, Expected credit losses

JEL Classification: G01, G18, G21, M41

working papers series