Does Fair Value Accounting Exacerbate the Pro-Cyclicality of Bank Lending?

Posted: 23 Jun 2016

See all articles by Biqin Xie

Biqin Xie

Office of Financial Research, U.S. Department of the Treasury

Date Written: March 1, 2016

Abstract

This study investigates whether fair value accounting contributes to the procyclicality of bank lending. Using banks’ approval/denial decisions on residential mortgage applications to capture banks’ supply of credit, I find no evidence that fair value accounting has procyclical effects on bank lending over the past two business cycles. I further identify two reasons for this result. First, the main accounting item distinguishing fair value accounting from historical cost accounting — unrealized gains and losses on available-for-sale securities — does not affect lending decisions. Second, unrealized gains and losses on available-for-sale securities are not procyclical, as the risk-free interest rate rises during some expansionary periods, resulting in unrealized losses, while the risk-free interest rate (and sometimes the default spread) falls during some recessionary periods, resulting in unrealized gains.

Keywords: Bank Lending; Fair Value Accounting; Procyclicality

JEL Classification: E32; G21; M41

Suggested Citation

Xie, Biqin, Does Fair Value Accounting Exacerbate the Pro-Cyclicality of Bank Lending? (March 1, 2016). Journal of Accounting Research, Vol. 54, No. 1, 2016, Available at SSRN: https://ssrn.com/abstract=2798779

Biqin Xie (Contact Author)

Office of Financial Research, U.S. Department of the Treasury ( email )

717 14th St NW
Washington, DC 20005
United States

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