Tainted Portfolios: How Impairment Accounting Rules Restrict Security Sales
Journal of Business Finance and Accounting, Vol. 46 (5-6), pp. 608-635, May/June 2019
45 Pages Posted: 3 Jan 2019 Last revised: 20 Jun 2019
Date Written: December 17, 2018
Contrary to claims that fair value accounting exacerbated banks’ securities sales during the recent financial crisis, we present evidence that suggests – if anything – that the current impairment accounting rules served as a deterrent to selling. Specifically, because banks must provide evidence of their “intent and ability” to hold securities with unrealized losses, there are strong incentives to reduce, rather than increase, security sales when market values decline to avoid “tainting” their remaining securities portfolio. Validating this concern, we find that banks incur greater other-than-temporary impairment (OTTI) charges when they sell more securities. We then find that banks sell fewer securities when their security portfolios have larger unrealized losses (and thus larger potential impairment charges), and these results are concentrated in banks with homogenous securities portfolios, expert auditors, more experienced managers, and greater regulatory capital slack. Overall, our results suggest that – contrary to critics’ claims – the accounting rules appear to have reduced banks’ propensity to sell their securities during the financial crisis.
Keywords: fair value accounting, financial crisis, impairment, OTTI, pro-cyclical, security sales, standard setting, auditor expertise
JEL Classification: G01, G21, M41, M42, M48
Suggested Citation: Suggested Citation