The IFRS Option to Reclassify Financial Assets out of Fair Value in 2008: The Roles Played by Regulatory Capital and Too-Important-To-Fail Status

Abstract

Amendment of IAS 39 by the IASB in 2008 provided an option to reclassify investments from fair value to historical cost. Whereas this option was available to all firms, it was particularly relevant to banks. We predict that “too important to fail” (TITF) banks took less advantage of this option than non-TITF banks because the political protection they enjoyed insulated them from regulatory pressure. Banks that did not enjoy this protection had greater reason to make use of the option to reclassify since doing so would protect their Tier 1 capital. As predicted, findings reveal that TITF banks made less use of the reclassification option to protect their Tier 1 capital and that there is a significant moderating influence of TITF status on the incentive to reclassify investments for banks with lower regulatory capital. This finding is consistent with TITF banks placing less weight on protecting regulatory capital than non-TITF banks, and thereby retaining flexibility to sell assets. Taken together, our findings provide evidence that accounting choices made by managers are affected by the importance of their firms to the economies in which they are domiciled.

Keywords: Too Important to Fail, Fair Value Accounting, Bank Regulation, Financial Crisis

JEL Classification: G14, G21, G28, M41, M48