Does Fair Value Accounting Exacerbate the Pro-Cyclicality of Bank Lending?
Posted: 23 Jun 2016
Date Written: March 1, 2016
Abstract
This study investigates whether fair value accounting contributes to the procyclicality of bank lending. Using banks’ approval/denial decisions on residential mortgage applications to capture banks’ supply of credit, I find no evidence that fair value accounting has procyclical effects on bank lending over the past two business cycles. I further identify two reasons for this result. First, the main accounting item distinguishing fair value accounting from historical cost accounting — unrealized gains and losses on available-for-sale securities — does not affect lending decisions. Second, unrealized gains and losses on available-for-sale securities are not procyclical, as the risk-free interest rate rises during some expansionary periods, resulting in unrealized losses, while the risk-free interest rate (and sometimes the default spread) falls during some recessionary periods, resulting in unrealized gains.
Keywords: Bank Lending; Fair Value Accounting; Procyclicality
JEL Classification: E32; G21; M41
Suggested Citation: Suggested Citation