The Impact of Contingent Commitment Disclosures on Bank Valuation

Abstract

Banks have become increasingly active in off-balance sheet activities, but little is known about the usefulness of disclosures of these activities. The unique quality about contingent commitments is that fees associated with these instruments are reported in the balance sheet while the face value of the commitment is reported off-balance sheet. This study examines two types of contingent commitments. My results show that supplementary disclosures on these activities provide incremental information about the value of the bank. In particular, disclosures on third party guarantees reflect the banks' potential liability as insurers, however, loan commitment disclosures appear to convey information about future loan opportunities. I also find that regulatory risk-based capital requirements and firm specific attributes affect the relative value of issuing these commitments. The value implications of these disclosures are relevant to the debate on disclosures of fair value of financial instruments (FAS 107) and whether contingent commitments are viewed by the market to be bank assets or liabilities.

JEL Classification: G21, M41