Financial Instruments Fair Value Accounting for (Not Against) the Banking Industry

CFS Working Paper No. 2003/21

45 Pages Posted: 21 Oct 2003

See all articles by Günther Gebhardt

Günther Gebhardt

Goethe Universität Frankfurt am Main

Rolf Reichardt

Landesbank Hessen-Thueringen Girozentrale

Carsten Wittenbrink

Dresdner Bank AG - Group Risk Control

Date Written: June 2003

Abstract

The paper analyses the effects of three sets of accounting rules for financial instruments - Old IAS before IAS 39 became effective, Current IAS or US GAAP, and the Full Fair Value (FFV) model proposed by the Joint Working Group (JWG) - on the financial statements of banks. We develop a simulation model that captures the essential characteristics of a modern universal bank with investment banking and commercial banking activities. We run simulations for different strategies (fully hedged, partially hedged) using historical data from periods with rising and falling interest rates.

We show that under Old IAS a fully hedged bank can portray its zero economic earnings in its financial statements. As Old IAS offer much discretion, this bank may also present income that is either positive or negative. We further show that because of the restrictive hedge accounting rules, banks cannot adequately portray their best practice risk management activities under Current IAS or US GAAP. We demonstrate that - contrary to assertions from the banking industry - mandatory FFV accounting adequately reflects the economics of banking activities. Our detailed analysis identifies, in addition, several critical issues of the accounting models that have not been covered in previous literature.

Keywords: financial instruments, fair value accounting, hedge accounting, accounting for banks, IAS, US GAAP, bank simulation

JEL Classification: G21, M41, M44, M47, G13

Suggested Citation

Gebhardt, Günther and Reichardt, Rolf and Wittenbrink, Carsten, Financial Instruments Fair Value Accounting for (Not Against) the Banking Industry (June 2003). CFS Working Paper No. 2003/21, Available at SSRN: https://ssrn.com/abstract=430260 or http://dx.doi.org/10.2139/ssrn.430260

Günther Gebhardt (Contact Author)

Goethe Universität Frankfurt am Main ( email )

Theodor-W.-Adorno-Platz 4
Hauspostfach 64
Frankfurt, 60629
Germany

HOME PAGE: http://much-magic.wiwi.uni-frankfurt.de/professoren/gebhardt/

Rolf Reichardt

Landesbank Hessen-Thueringen Girozentrale ( email )

Main Tower
Neue Mainzer Strasse 52-58
60311 Frankfurt am Main
Germany

Carsten Wittenbrink

Dresdner Bank AG - Group Risk Control ( email )

Jurgen-Ponto-Platz 1
Frankfurt, 60301
Germany

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