Liberal Fair Value Accounting in Banks: A South African Case Study

Research findings on the role of fair value accounting (FVA) in the global financial crisis suggest that FVA is not applied neutrally by banks. The results of FVA are accepted when they contribute to higher profits and are actively resisted when they lead to losses. The aim of this article is to investigate how FVA is practically applied by banks in detail. The focus is on banks as most of their assets are financial instruments and thus potentially fair valued, and banks’ behaviour is significantly influenced by their regulatory environment. The research objective is pursued by using a case study of two South African banks. One of these is the largest and most systemically important bank in the South African system and the other is on the crossover between systemic and not systemic. It is found that FVA as applied by these two banks is not neutral. Also included is a demonstration of a method to derive the unrealised portion of profit and equity, the identification of the gap between assets and liabilities at fair value as the driver of where in a banking group FVA profits and losses are realised, and the finding that the restatement of comparative figures was used to circumvent the prohibition on reclassifications into and out of the ‘designated as at fair value’ category.     

Banks’ Financial Reporting and Financial System Stability

The use of accounting measures and disclosures in banks’ contracts and regulation suggests that the quality of banks’ financial reporting is central to the efficacy of market discipline and nonmarket mechanisms in limiting banks’ development of debt and risk overhangs in economic good times and in mitigating the adverse consequences of those overhangs for the stability of the financial system in downturns. This essay examines how research on banks’ financial reporting, informed by the financial economics literature on banking, can generate insights about how to enhance the stability of the financial system. We begin with a foundational discussion of how aspects of banks’ accounting and disclosures may affect stability. We then evaluate representative papers in the empirical literature on banks’ financial reporting and stability, pointing out the research design issues that empirical accounting researchers need to confront to develop well‐specified tests able to generate reliably interpretable findings. To this end, we provide examples of settings amenable to addressing these issues. We conclude with considerations for accounting standard setters and financial system policy makers.     

A comparison of conventional versus Islamic banking customers attitudes and judgment

This investigates the impact of customer attitude and judgment regarding conventional and Islamic banking system in Pakistan. This study attempts to find out, how the customers of Islamic banks perceive about Islamic banking practices in terms of Shariah compliance and conventional banking system regarding earning more profits. This study consists on primary data through a well design questionnaire. Four hundred and thirty (430) questionnaires were distributed among different customers of all three types of banking, such as Islamic, conventional and stand-alone branches in order to investigate customer’s attitude and judgment toward banking system. The findings indicate that overall 28% of Islamic banking customers don’t know the essential concept of Islamic financial institution’s in Pakistan. Furthermore, 54% customers of conventional banking show their interest to convert their accounts toward Islamic banks.

     

International banking: Current issues in perspective

Recent developments in international banking have raised new problems and policy issues as well as new opportunities for banks. To put these developments in perspective and analyze a number of policy issues of current concern is the purpose of the paper. In particular it sets out to explain three important aspects: the dollar's pre-eminence in spite of the ‘multinationalization’ of international banking, the more rapid growth of the international compared with the domestic banking sector, and the dominant role of banks in the expansion of international finance rather than other financial intermediaries or direct lending.     

The Puzzle Between Banking Competition and Profitability can be Solved: International Evidence from Bank-Level Data

This article applies the GMM techniques for dynamic panels using bank-level data for 61 countries over the period 1992 to 2006 to re-investigate the impact of banking competition on profitability. The extant literature, which ignores influence factors, presents ambiguity towards the impact of banking competition on profitability. However, when the effects of a broad range of factors are taken into consideration, five conclusions are reached. First, along with the change in market structure, a higher degree of activity restriction enhances banks’ profits. Second, restrictions on the rights of commercial banks to engage in securities, insurance, and other non-banking-related business, along with restrictions on the entry of foreign banks into these markets, weaken the positive relationship between banking competition and profits. Third, a higher degree of efficiency within the judicial system and the added protection afforded to investors may weaken or else have no impact on the positive relationship. Fourth, the positive relationship may weaken in countries having a sound financial system or high income per capita. Finally, greater competitive pressure facing banks may weaken or eliminate the impact of banking competition on profit.     

Bank Earnings Management in Emerging Market Economies: The Case of Mexico

In the mid-late 1990s, developing countries in several parts of the world experienced severe currency devaluations that were accompanied by deep economic downturns. For some regions, international financial organizations have documented that deficient financial reporting standards and practices contributed to the onset and magnitude of the crises by understating banks’ problem loans and capital adequacy problems. However, little research has been conducted concerning the role of financial reporting in the post-devaluation reconstruction of financial systems. As such, this paper examines the role of financial reporting in the post-1994 devaluation restructuring of the Mexican banking system. Emphasis is placed on examining whether the country's three largest banks delayed the recognition of loan losses in the late 1990s. The results provide evidence that banks took advantage of weaknesses in financial reporting standards to delay the recognition of loan losses.     

Efficiency in Turkish banking: post-restructuring evidence

Turkish banking sector went through a significant restructuring process in the aftermath of the country's financial crisis of 2000–2001. In this paper, we analyze the evolution of banking performance using a novel approach due to Ray [(2007). “Shadow Profit Maximization and a Measure of Overall Inefficiency.” Journal of Productivity Analysis 27, 231–236]. We derive ‘shadow unrealized profit scores’ as well as ‘shadow input–output prices’ for each year and bank in the sector from 2002 to 2011. We argue these scores operationalize the Hicksian concept of ‘monopolistic quiet life’. We provide some evidence the sector came closer to the ‘zero profit condition’ as well as displaying a closer approximation to the ‘law of one price’ over time. We show the variability of these ‘shadow prices’ essentially coincides with that of corresponding actual prices. We utilize shadow price information to show that business models and competitive choices of banks differ across ownership types with foreign banks competing on the broadest front compared to state-owned and privately owned Turkish banks.     

Can banks individually create money out of nothing? — The theories and the empirical evidence

This paper presents the first empirical evidence in the history of banking on the question of whether banks can create money out of nothing. The banking crisis has revived interest in this issue, but it had remained unsettled. Three hypotheses are recognised in the literature. According to the financial intermediation theory of banking, banks are merely intermediaries like other non-bank financial institutions, collecting deposits that are then lent out. According to the fractional reserve theory of banking, individual banks are mere financial intermediaries that cannot create money, but collectively they end up creating money through systemic interaction. A third theory maintains that each individual bank has the power to create money ‘out of nothing’ and does so when it extends credit (the credit creation theory of banking). The question which of the theories is correct has far-reaching implications for research and policy. Surprisingly, despite the longstanding controversy, until now no empirical study has tested the theories. This is the contribution of the present paper. An empirical test is conducted, whereby money is borrowed from a cooperating bank, while its internal records are being monitored, to establish whether in the process of making the loan available to the borrower, the bank transfers these funds from other accounts within or outside the bank, or whether they are newly created. This study establishes for the first time empirically that banks individually create money out of nothing. The money supply is created as ‘fairy dust’ produced by the banks individually, "out of thin air".     

A lost century in economics: Three theories of banking and the conclusive evidence

How do banks operate and where does the money supply come from? The financial crisis has heightened awareness that these questions have been unduly neglected by many researchers. During the past century, three different theories of banking were dominant at different times: (1) The currently prevalent financial intermediation theory of banking says that banks collect deposits and then lend these out, just like other non-bank financial intermediaries. (2) The older fractional reserve theory of banking says that each individual bank is a financial intermediary without the power to create money, but the banking system collectively is able to create money through the process of ‘multiple deposit expansion’ (the ‘money multiplier’). (3) The credit creation theory of banking, predominant a century ago, does not consider banks as financial intermediaries that gather deposits to lend out, but instead argues that each individual bank creates credit and money newly when granting a bank loan. The theories differ in their accounting treatment of bank lending as well as in their policy implications. Since according to the dominant financial intermediation theory banks are virtually identical with other non-bank financial intermediaries, they are not usually included in the economic models used in economics or by central bankers. Moreover, the theory of banks as intermediaries provides the rationale for capital adequacy-based bank regulation. Should this theory not be correct, currently prevailing economics modelling and policy-making would be without empirical foundation. Despite the importance of this question, so far only one empirical test of the three theories has been reported in learned journals. This paper presents a second empirical test, using an alternative methodology, which allows control for all other factors. The financial intermediation and the fractional reserve theories of banking are rejected by the evidence. This finding throws doubt on the rationale for regulating bank capital adequacy to avoid banking crises, as the case study of Credit Suisse during the crisis illustrates. The finding indicates that advice to encourage developing countries to borrow from abroad is misguided. The question is considered why the economics profession has failed over most of the past century to make any progress concerning knowledge of the monetary system, and why it instead moved ever further away from the truth as already recognised by the credit creation theory well over a century ago. The role of conflicts of interest and interested parties in shaping the current bank-free academic consensus is discussed. A number of avenues for needed further research are indicated.     

Does banking deregulation affect accounting conservatism?

This study examines the effect of banking competition on borrowing firms’ conditional accounting conservatism (i.e., asymmetric timely loss recognition). The context of the study is the staggered passage of the Interstate Banking and Branching Efficiency Act (IBBEA), the deregulation that permits banks to establish branches across state lines and increases bank competition. I find that firms report less conservatively after the passage of the IBBEA in their headquarter states. The effect on conditional conservatism is stronger for firms in states with a greater increase in competition among banks, firms that are more likely to borrow from in-state banks, firms with greater financial constraint, and firms subject to less external monitoring. Additional tests confirm that the decline in conditional conservatism is observed only after the adoption of IBBEA and lasts for two years. The findings indicate that banks tend to “lowball” borrowers when competition arises by relaxing their demand for conservative reporting. Overall, this study highlights the unintended impacts of banking competition on borrowing firms’ financial reporting.     

How do European banks portray the effect of policy interest rates and prudential behavior on profitability?

European policy interest rates have been low and trending downwards for almost a decade now and expectations do not seem to change. Hence, in such an environment, this paper investigates whether and how banks’ prudential behavior has influenced profitability across the European banking sector from 1999 to 2015. Using a dynamic panel model, we clearly find that banks’ financial resilience, proxied by the asymmetric Z-score and two financial ratios, affects profits: more cautious banks record higher profits. This result is confirmed by the two overall measures of profitability, namely the Return on Average Assets and Equity, but not for the Net Interest Margins. Furthermore, our analysis suggests that monetary policy's main instrument adversely affects bank income. Nevertheless, when policy interest rates are particularly low, the effect on Net Interest Margin is still positive, while the effect on the overall profitability becomes negative. These results induce that European banks succeed in increasing their profitability despite a compression of their net interest income.     

Banking for the public good

Bank shareholders cannot be expected to provide good stewardship to banks because there is a conflict of interests between the shareholder owners and a non-mutually owned bank's depositors; who provide the bulk of the funds in traditional retail banks and are willing to accept a lower return on their savings than shareholders, in return for lower risk exposure. Regulation is required to protect depositors where deposit insurance schemes are at best partially funded and underwritten by taxpayers, who in turn need to be protected, and to deliver financial stability, a public good. Once some banks become ‘too big (to be allowed) to fail’ (TBTF), they enjoy additional implicit public (taxpayer) insurance that enables them to fund themselves more cheaply than smaller banks, which gives them a competitive advantage. The political influence of big banks in the US and the UK is such that they can be regarded as financial oligarchies that have hitherto successfully blocked far reaching structural reform in the wake of the ‘Global Financial Crisis’ and lobbied successfully for the financial sector liberalisation that preceded it. The TBTF problem and associated moral hazard have been worsened by mergers to save failing banks during the crisis and as a result competition within a number of national banking systems, notably the UK, has been significantly reduced. Solutions alternative to making the banks small enough to be allowed to fail are considered in this paper, but it is difficult to be convinced that they will deliver banks that promote the common or public good. It is argued that regulating retail banking as a utility and pooling insurance against financial instability using pre-funded deposit insurance schemes, with risk related premiums that can also serve as bank resolution funds, should be pursued; and that capital leverage ratios and/or Financial Activity Taxes might be used to ‘tax’ the size of banks.     

Bank Disclosure and Market Assessment of Financial Fragility: Evidence from Turkish Banks’ Equity Prices

In this paper we explore whether Turkish banks with worsening indicators of financial fragility were subject to market monitoring during the years leading to the 2000/2001 crisis, and how the quality and timeliness of the disclosure affect market reaction. We find that shareholders reacted negatively to indicators of financial fragility such as increases in maturity mismatches, currency mismatches, and non-performing loans, showing shareholders’ concerns about the impact of financial fragility indicators on future profits. We also find that audited statements that show larger reporting lags, are not informative, pointing to the need of improving their timeliness. Finally, our study suggests that the finding that securities prices react to financial fragility indicators should not be taken as sufficient evidence of banks’ safety and soundness.     

Back to the basics in banking? A micro-analysis of banking system stability

This paper analyzes the relationship between banks’ divergent strategies toward specialization and diversification of financial activities and their ability to withstand a banking sector crash. We first generate market-based measures of banks’ systemic risk exposures using extreme value analysis. Systemic banking risk is measured as the tail beta, which equals the probability of a sharp decline in a bank’s stock price conditional on a crash in a banking index. Subsequently, the impact of (the correlation between) interest income and the components of non-interest income on this risk measure is assessed. The heterogeneity in extreme bank risk is attributed to differences in the scope of non-traditional banking activities: non-interest generating activities increase banks’ tail beta. In addition, smaller banks and better-capitalized banks are better able to withstand extremely adverse conditions. These relationships are stronger during turbulent times compared to normal economic conditions. Overall, diversifying financial activities under one umbrella institution does not improve banking system stability, which may explain why financial conglomerates trade at a discount.     

Advances in the Financial Reporting of Mexican Banks: An Evaluation of Post-Devaluation Reporting Practices

In 1994, Mexico underwent a severe peso devaluation. Thereafter, the country’s financial system experienced severe financial stress as loan defaults forced the government to undertake a program to rescue the country’s banks and obtain international financial assistance. One of the measures involved the reformulation of the financial reporting principles used by the country’s banks. The standards, which are contained in the Mexican National Banking and Securities Commission’s Circular 1343 (1997), were designed to provide Mexican banks with a comprehensive set of financial reporting standards and to bring the financial reporting practices of Mexican financial institutions closer to international standards. However, while the standards contain several improvements in the fundamental aspects of financial reporting for Mexican banks, they lack some important measurement and disclosure provisions contained in international standards. Given this tendency, this paper examines the post-devaluation (1998) financial reporting practices of Mexican banks. Emphasis is placed on comparing the reporting practices contained in the banks’ 1998 financial statements with the requirements of Circular 1343, the standards published by the Mexican Institute of Public Accountants (MIPA), International Accounting Standards Committee (IASC) standards, and Financial Accounting Standards Board (FASB) rules.     

银行可持续发展:寻求金融创新与风险管理的适度平衡

在宏观经济面临的不确定性越来越大、宏观调控政策日趋频繁的复杂环境下,商业银行要想持续、稳健发展就必须加大金融创新的力度.但金融创新在为银行拓展新的经营空间、创造利润的同时也引致了新的风险.本文论述了商业银行金融创新的发展方向并对金融创新的风险点进行了识别和分析,认为当前的银行业改革必须在金融创新与风险管理之间寻求适度的平衡,这在金融全面开放的后WTO时代,对于推动银行业实施战略转型从而实现可持续发展具有重要的意义.     

商业银行与中小企业共赢之道——供应链融资

供应链融资是近年来全球商业银行界最关注的一项金融业务。我国的商业银行通过向供应链的各个环节提供融资支持,促进了中小企业发展和贸易复苏,为我国经济摆脱金融危机负面影响起到了积极的促进作用,商业银行的客户基础和利润来源也得以扩展。     

Banking Market Size Structure and Financial Stability: Evidence from Eight Asian Countries

Using commercial bank data from eight major Asian countries, we examine the relationship between the banking market size structure and the stability of financial institutions. We also analyze the effect of bank upsizing on the financial stability. Our results show that a rise in large banks’ market power, accompanying an increase in their market shares, lowers the capital adequacy of small banks. Small banks’ nonperforming loans and the possibility of their bankruptcy also increase as large banks’ market shares rise. We further show that larger banks tend to have lower capital adequacy ratios, liquidity ratios, and distance-to-default ratios. Our study suggests that large banks’ greater market shares are associated with small banks’ financial instability. Overall, these findings are consistent with the notion of the recent banking literature that has important antitrust policy implications.     

Why high productivity growth of banks preceded the financial crisis

The high levels of operating efficiency, profits, and market values for banks in the years before the financial crisis raise reasonable doubts about the accuracy of the assessments of the efficiency of banking intermediation. We examine the productivity growth in Spanish banks in the pre-crisis period by separating out the contributions to productivity growth from business practices and from industry-wide technological progress. We find that more than two thirds of the estimated productivity growth in the years 2000–2007 is attributed to banks’ practices, such as the expansion of credit in the housing market, the high recourse to securitization and short-term finance, the reduction in liquidity holdings, and the leveraging process of banks’ balance sheets, that the literature claims are the ultimate causes of the crisis. We estimate that the remaining cumulative annual growth rate is 2.8% for the industry’s technical progress, which is similar to that in the period of 1992–2000.     

Factors influencing the profitability of domestic and foreign commercial banks in the European Union

Using bank level data this paper examines how bank's specific characteristics and the overall banking environment affect the profitability of commercial domestic and foreign banks operating in the 15 EU countries over the period 1995–2001. The results indicate that profitability of both domestic and foreign banks is affected not only by bank's specific characteristics but also by financial market structure and macroeconomic conditions. All the variables, with the exception of concentration in the case of domestic banks profits, are significant although their impact and relation with profits is not always the same for domestic and foreign banks.