Why Do Banks Gain and Loss Sell Securities?

Abstract

Accounting standards exclude most securities gains and losses from net income until the securities are sold, providing incentives to sell securities based on the gain and loss positions. We deepen understanding of this behavior in a variety of ways. First, we find that what the prior literature calls earnings “smoothing” is more precisely characterized as boosting low earnings; banks boost low earnings via gain selling but do not materially reduce high earnings via loss selling. Second, we find this behavior more in line with opportunism than with signaling, and a specific opportunistic motive is to meet the bank regulatory guideline for dividend payments. Finally, we uncover additional tendencies of banks which include selling larger portions of gain positions than loss positions, more aggressively using gain selling to offset a given amount of loss selling than vice versa, and selling securities in a pattern that conforms to prospect theory. 

Keywords: banks, securities, gain selling, loss selling smoothing, fair value, accounting JEL classification: M41, M48

JEL Classification: M41, M48