Banks' Discretionary Use of Fair-Value Accounting, Capital Requirement Regulation, and Bank Lending

42 Pages Posted: 25 Jul 2013 Last revised: 21 Sep 2017

See all articles by Carlos Corona

Carlos Corona

Carnegie Mellon University

Lin Nan

Purdue University

Gaoqing Zhang

University of Minnesota

Date Written: September 15, 2017

Abstract

This paper examines banks' accounting choices between fair-value and historical-cost accounting when reported accounting information is used for capital requirement regulation. In choosing fair-value relative to historical-cost, banks must consider potential benefits of additional lending in good times against potential cost of a smaller lending or even insolvency in bad times. If the lending return is inelastic to aggregate lending, a higher capital requirement reduces fair-value accounting usage. However, if the lending return is elastic to aggregate lending, a higher capital requirement encourages the usage of fair-value accounting when the initial capital ratio is low. Our analysis also provides some policy implications. We find mandating a uniform fair-value accounting method is socially desirable when the capital requirement is extremely tight, and mandating a uniform historical-cost method is socially optimal when the capital requirement is extremely loose. When the capital requirement is intermediate, allowing discretion is socially optimal.

Keywords: banking, fair value, accounting, capital requirement, historical cost

JEL Classification: D7, D8

Suggested Citation

Corona, Carlos and Nan, Lin and Zhang, Gaoqing, Banks' Discretionary Use of Fair-Value Accounting, Capital Requirement Regulation, and Bank Lending (September 15, 2017). Available at SSRN: https://ssrn.com/abstract=2298184 or http://dx.doi.org/10.2139/ssrn.2298184

Carlos Corona (Contact Author)

Carnegie Mellon University ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

Lin Nan

Purdue University ( email )

100 S Grant St
West Lafayette, IN 47907
United States
7654960551 (Phone)

Gaoqing Zhang

University of Minnesota ( email )

321 19th Avenue South
Minneapolis, MN 55455
United States

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