How did Financial Reporting Contribute to the Financial Crisis?
Mary E. Barth
Stanford University - Graduate School of Business
Wayne R. Landsman
University of North Carolina Kenan-Flagler Business School
May 6, 2010
European Accounting Review 19, no. 3: 399-423.
Rock Center for Corporate Governance at Stanford University Working Paper No. 79
We scrutinize the role financial reporting for fair values, asset securitizations, derivatives, and loan loss provisioning played in the Financial Crisis. Because banks were at the center of the Financial Crisis, we focus our discussion and analysis on the effects of financial reporting by banks. We conclude fair value accounting played little or no role in the Financial Crisis. However, transparency of information associated with asset securitizations and derivatives likely was insufficient for investors to assess properly the values and riskiness of bank assets and liabilities. Although the FASB and IASB have taken laudable steps to improve disclosures relating to asset securitizations, in our view, the approach for accounting for securitizations in the IASB’s Exposure Draft that would require banks to recognize whatever assets and liabilities they have after the securitization is executed better reflects the underlying economics of the securitization transaction. Regarding derivatives, we recommend disclosure of more disaggregated information, disclosure of the sensitivity of derivatives’ fair values to changes in market risk variables, and implementing a risk-equivalence approach to enable investors to understand better the leverage inherent in derivatives. We also conclude that because the objectives of bank regulation and financial reporting differ, changes in financial reporting needed to improve transparency of information provided to the capital markets likely will not be identical to changes in bank regulations needed to strengthen the stability of the banking sector. We discuss how loan loss provisioning may have contributed to the Financial Crisis through its effects on procyclicality and on the effectiveness of market discipline. Accounting standard setters and bank regulators should find some common ground. However, it is the responsibility of bank regulators, not accounting standard setters, to ensure the stability of the financial system.
Number of Pages in PDF File: 38
Keywords: Financial Statements, Asset-Backed Financing, Accounting Bank Assets, Standards Global Financial Crisis, 2008-2009
Date posted: May 10, 2010 ; Last revised: September 19, 2012