Mark-to-Market, Loan Retention, and Loan Origination
43 Pages Posted: 18 Nov 2009 Last revised: 26 Sep 2017
Date Written: September 1, 2017
We study the effects of mark-to-market accounting (MTM) on banks’ loan origination and retention decisions. We point out a conceptual shortcoming of MTM. Loan prices are informative in equilibrium but this price discovery is sustained by the good banks’ costly retention. The attempt to exploit the information in equilibrium prices through MTM makes price discovery more costly or even impossible. We show that, relative to historic cost accounting (HC), MTM has three consequences. First, it improves the accuracy of loan valuation ex post. Second, it forces the good banks to retain even more risk exposure on their balance sheet. Finally, it can reduce ex-ante origination efforts. To the extent that a lower loan quality and banks’ excessive risk exposure are two important ingredients for financial crises, we identify one mechanism through which MTM could contribute to financial crises.
Keywords: Mark-to-market accounting, historic cost accounting, loan quality, financial crisis
JEL Classification: G01, G21, G30, M41
Suggested Citation: Suggested Citation