Forward-looking and Incentive-compatible Operational Risk Capital Framework

The recent financial crisis has lead to heated debates on the pros and cons of fair value accounting from the perspectives of illiquidity and procyclicality. Previous research investigates the relationship between fair value accounting and procyclicality and finds mixed evidence of this relationship during economic recessions.However, few studies examined the relationship between fair value accounting and the financial crisis during economic booms. The purpose of this study is to examine whether fair value accounting promotes procyclicality by focusing on securitization transactions during economic booms.We examine the relationship between securitization accounting and procyclicality by using a parsimonious model. The findings are as follows. When a gain on sale is recognized under certain conditions, sale accounting decreases the leverage ratio compared with that before the securitization transaction. Banks increase assets to maintain the target leverage ratio. Furthermore, if banks conduct securitization transactions and adopt sale accounting, the leverage ratio decreases; therefore, banks increase assets to maintain the leverage ratio. It is expected that both sale accounting and fair value accounting promote procyclicality during economic booms.This study makes two contributions to accounting literature and accounting standard settings. First, it proposes a new perspective on the relationship between fair value accounting and procyclicality. Second, this study suggests that accounting standard setters reconsider the movement of accounting for securitization.

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Can accounting rules be made neutral for bank capital regulation?

Song¹

2012

JGR

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This paper evaluates several methods which can possibly be used to minimize the pro-cyclical impact of accounting rules on bank capital regulation. Improving accounting rules cannot eliminate the pro-cyclicality problem as there cently proposed expected credit loss impairment model for historical cost accounting may be moving towards using information inputs for fair values. Limiting the trading activities accounted for by fair values may reduce the pro-cyclicality. However, it cannot eliminate the impact of fair values in a liquidity crisis. The most effective method is to exclude the unrealized accounting gains or losses from regulatory capital. But it needs a report of capital ratios based on accounting measures to help regulators read the early warning signals emitted by the accounting information.

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Forward-looking and Incentive-compatible Operational Risk Capital Framework

Cited by 3 publications

References 26 publications

Is Operational Risk Regulation Forward-looking and Sensitive to Current Risks?

Is Operational Risk Regulation Forward-looking and Sensitive to Current Risks?

Fair value accounting and procyclicality: accounting for securitization

Can accounting rules be made neutral for bank capital regulation?

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