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Market-Based Solutions to Vital Economic Issues

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Market-Based Solutions to Vital Economic Issues
Research
Nov 1, 2014

Thoughts on Financial Accounting and the Banking Industry

Abstract

Complementing the recent review of the banking literature in accounting by Beatty and Liao (2014), I offer my own thoughts on the role of financial accounting in banking. I focus my discussion on real effects of accounting policy choices on individual bank risk taking and codependence of risk among banks. I emphasize the role played by managerial discretion over accounting decisions in influencing bank stability through two distinct accounting channels: accounting numbers as numerical quantities and bank transparency. Accounting policy can affect bank stability through its influence over the accounting numbers as quantitative inputs into numerical calculations of regulatory covenants such as bank capital and leverage ratios. Accounting policy choices can also affect bank transparency which can impact bank stability by influencing the intensity of market monitoring of bank risk-taking, the extent of financing frictions facing banks, and banks’ opportunities to engage in risk-shifting activities. I also offer ideas on future research directions.

Note: Research papers posted on SSRN, including any findings, may differ from the final version chosen for publication in academic journals.


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