Banking Industry Says Proposed Changes to Fair Value Accounting Would Contravene G-20 Goals by Disrupting Convergence and Increasing Procyclicality

Ahead of the G-20 meeting, a letter to the Treasury and the Fed from the banking industry emphasized that the fair value accounting changes proposed by the IASB and FASB would increase procyclicality, disrupt the global convergence of accounting standards, and undermine the banking business model. As such, the proposals fly in the face of the G-20’s endorsed reform of accounting standards. The American Bankers Association urged Treasury and the Fed to tell the G-20 conference that the fair value accounting proposals are contrary to the G-20’s own recommendations.

The ABA said that requiring banking institutions to follow mark-to-market accounting simply because the nature of their business is financial ignores the traditional bank business model and puts banks at a disadvantage. This is primarily because operating results would be based on the volatility of the marketplace rather than the cash flows that are received. Mandating a new accounting model for banking institutions that is as broad in scope as the models being discussed by the standard setters would cause massive disruptions to the banking industry and to the economy.

The proposals would decrease the ability of investors and regulators to understand the business of banking. Mark-to-market does not reflect the business model for the traditional banking business. While the ABA agrees with the use of mark-to-market for assets that are traded, such as equity securities, the traditional banking model is to hold loans and debt instruments for their contractual cash flows.

Therefore, in the ABA’s view, the increase in the use of mark-to-market that is being discussed by the standard setters would provide misleading information. The proposals are also contrary to the G-20 recommendation that the accounting standard setters should improve standards for the valuation of financial instruments based on their liquidity and investors holding horizons. Similarly, the proposals do not meet the Basel Committee’s principles, recently endorsed by the G-20 Finance Ministers, that the new standard should reflect the business model so that banking transactions are portrayed in a robust and consistent manner in line with their economic substance.

Both FASB and the IASB propose to increase the use of mark-to-market accounting, which experts believe is procyclical. Thus, the proposals are contrary to the recommendations of the G-20 to make accounting less procyclical. They are also contrary to the Treasury principle that regulatory capital and accounting frameworks should be modified to reduce their procyclicality.

Compared with the historical cost approach, fair value accounting intensifies market fluctuations. Commenters believe that fair value accounting magnifies the changes in the value of financial assets and increases the volatility of returns through the profit and loss account as a consequence. As a result of the massive collateralized securities they held, financial institutions registered mounting unrealized losses which actually involved no cash flow under the fair value rule. Though these losses were only meaningful in accounting, the procyclical view is that such astronomical book losses distorted investors' expectations and formed a vicious cycle of tumbling prices and asset write-downs

Further, FASB and IASB have two different proposals with two different time frames for implementation, noted the ABA, which would disrupt the goal of international convergence of accounting standards. This scenario contradicts the G-20 recommendation that the standard setters should make significant progress towards a single set of high quality global accounting standards

The current economic crisis has demonstrated how important it is to ensure that these new accounting standards, particularly loans and debt securities, be the same, globally. The IASB plans to finalize its rules for use by year-end 2009, said the ABA, while the FASB plans to finalize its rules in 2010. Therefore, it appears that either U.S. GAAP will not be similar to international standards, or, for the sake of convergence, U.S. constituents may be faced with having to accept what will be recently-enacted international rules without having the ability to have an appropriate level of due process.

In an earlier letter to FASB and the IASB, the banking industry said that the joint FASB-IASB project on fair value accounting should refrain from broadly expanding mark-to-market accounting to loans and debt securities. In a white paper sent with the letter, the ABA said that accounting for loans and debt securities should be based on how a company manages its business. Portions of the business that are managed to maximize current fair values should use mark-to-market, while those that manage cash flows should use amortized cost, accompanied by a robust impairment process, which includes recording impairment based on expected losses over a horizon that can be reasonably estimated.

In the ABA’s view, maintaining amortized cost valuations for loans and securities in the traditional banking segment gives investors a simple and accurate way to view how the organization manages its portfolio. The investor can easily see what amounts are due to the bank, how much is expected to actually be collected, and what level of yields are being earned. Any model that attempts to provide a “one size fits all” approach to loans and securities provides irrelevant information about a business entity, and therefore, greatly reduces the usefulness of such information to investors.

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