Banks’ Financial Reporting and Financial System Stability

Abstract

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.

The contribution of bank regulation and fair value accounting to procyclical leverage

“…To allow for the possibility that bank (time) factors are not temporally (cross-sectionally) invariant, we re-estimate Eqs. (4) and (5) including bank and macroeconomic variables (Beatty and Liao 2014;Acharya and Ryan 2016;Laux and Rauter 2017). The bank variables include lagged equity market-to-book ratio, lagged percentage change in loan growth, an indicator variable for whether the bank changed its dividend, lagged leverage, and change in the ratio of regulatory capital to accounting equity.…”

The Economics of Disclosure and Financial Reporting Regulation: Evidence and Suggestions for Future Research

“…Our definition of rules encompasses financial reporting and accounting standards. However, we largely exclude work on bank regulation as it is separately discussed in this journal issue by Acharya and Ryan [].…”

Macro- And Microprudential Regulations and Their Effects on Procyclicality of Solvency and Liquidity Risk

“…Another stream in the literature focuses on procyclicality of banking risk [Czerwińska, Jajuga 2016;Olszak 2015], and in particular of leverage [Adrian, Shin 2010;Acharya, Viswanathan 2010;Acharya, Ryan 2016;Laux, Rauter 2016;] and on procyclicality of liquidity risk, proxied by loans to deposits ratio (LTD, see e.g. Olszak and Kowalska [2016].…”

“…It seems better to proxy this procyclicality by looking at the association between leverage and the business cycle (as suggested in a stylized paper by Bank of England [2009]). Therefore, Acharya and Ryan [2016] and Laux and Rauter [2016] recommend capturing this procyclicality by looking at the association between leverage growth and the business cycle. Some papers on procyclicality of leverage show that leverage plays a significant role in the amplification of financial shocks through balance sheets [Adrian, Shin 2010;Acharya, Viswanathan 2010].…”

“…In this study, we contribute to previous research in this area [see: Adrian, Shin 2010;Haq, Heaney 2012;Acharya, Viswanathan 2010;Acharya, Ryan 2016;Laux, Rauter 2016] by looking at the role of macroprudential policy and microprudential regulations in the link between the business cycle and bank leverage, as well as bank liquidity risk across countries. We aim to answer several questions.…”