Fair Value Accounting Under The Prudential Supervision Of The Financial Perspective

The financial crisis, triggered by American subprime mortgage crisis in August 2007, has gradually turned into a global crisis. The fair value accounting (FVA) is highly a controversial issue and leads to a major policy debate involving among the stakeholders around the world. Some critics argue that FVA have the procyclical effects, significantly contributed to the financial crisis and exacerbated its severity for financial institutions in the U. S. and around the world. On the other hand, FVA proponents argue that FVA merely plays the role of the proverbial messenger rather than one of risk sources, because it promotes the transparency of financial information disclosure, helps the investors to understand the accounting information, strengthens the elasticity of the financial system and contributes to financial stability. Thus, the debates of both sides focus on whether FVA has the procyclical effects and whether it brings about adverse effects of financial stability. The unprecedented debates not only affect the revision of FVA but also give impetus to reform the prudential supervision. Political forces (for example G20, Financial Stability Board and Financial Crisis Advisory Group) step in establishing and amending accounting standards, which provides huge pressure on accounting standard setting agencies and gives impetus to reform fair value accounting. At the post-crisis era, under the condition that we keep relative independentability of accounting standards, it is the most important issue for us to think about how to improve accounting standards (for example measuring and disclosing the fair value of financial instruments in non-active markets, the impairments of financial assets and information disclosure), and how to coordinate the different issues between accounting and prudential supervision. Based on the historical background, this dissertation studies the procyclical effects of the fair value accounting through empirical analysis, and resolves financial stability from information disclosure perspective. The fundamental cause of financial crisis is the unbalance of economic structure, financial innovation, failure of risk management and financial supervision, but the accounting itself has strong economic cor sequences (Zeff,1978; Scott,2000). Procyclical effects of fair value accounting bring about adverse effects for financial stability. This dissertation emphasizes that the reform of fair value accounting normally improves the transparency of accounting information, which will further strengthen the pressure resistance ability of financial institutions. But fair value accounting increases the uncertainty of risk and measurement error during the financial crisis. Risk taking will likely become more procyclical than before, and will result in the vulnerability of the financial system. While maintaining financial stability is an important duty of prudential supervision, accounting can provide fundamental information for the decision of financial stability. Accounting information can alleviate the information asymmetry of the financial market and evaluate the risk of financial system. Accounting information is the core of financial stability and the foundation of internal risks evaluation, capital supervision and solvency analysis, and it affects the evolving process and the efficiency of financial market. Thus, the best way to overcome the financial crisis is to provide accurate, complete and authentic information for market participants (investors, accounting standard setting agencies, governmental supervisors and securities regulators) and improve the transparency of the market information. So this dissertation insists on fair value accounting, and set up an ideal information framework from perspective of financial stability. Through this framework, market participants will obtain not only the information as estimates of the current financial condition, estimates of risk profiles, and the uncertainty of measures from the micro-perspective, but also the information as the relativity of risk, the probability of risk contagion, and the systematic risk from the macro-perspective.In order to alleviate adverse effects of the procyclical effects for financial stability, the different objectives and interests of accounting and prudential supervision result in different or even conflicting strategies. Only the accounting and the prudential supervision really coordinate and cooperate can we solve the procyclical effects of fair value accounting. This can not only establish long-acting mechanism of the financial stability, but also reduce maximum adverse effects of the procyclical effects of fair value accounting, under the condition of keeping relative independentability of accounting standards. The relationship between accounting and the prudential supervision will be clearly separated, but their ultimate goal is to protect the investors and social interests, improve the quality and transparency of the accounting information, and allocate the resource more reasonably. The coordination and cooperation between the accounting and the prudential supervision, and narrowing the differences between the accounting and prudential supervision, will not only reduce the cost but also improve the transparency.From an ideal information framework of financial stability, the information of the fair value is the core. The fair value is involved in the valuation of assets and liabilities, it is also involved in risk assessment and measurement of error. So at the time of post-crisis, we should strengthen the study of fair value measurement in the inactive markets in order to provide the authentic accounting information and improve the pressure resistance ability of financial institutions. At present, the measurements of assets and liabilities don't really absorb the technology of risk management. So when the markets are no longer active, the measuring of the fair value should be coordinated with the assessing of risks and absorbs the experience of risk management in order to supply the useful information for the investors. The accounting information has the features of public good, so it will tend to be undersupplied. Therefore the accounting should coordinate with prudential supervision in the disclosure of risk information, which can not only reduce the overloaded information but also improve the transparency. At present, the banks prepare respectively the financial reporting under IFRS and regulations under Basel, and there are some differences between them. So narrowing the differences between the accounting and prudential supervision not only improves the operability of the accounting standards, but also helps establish a unified information disclosure framework and maintains the financial stability.Based on the guidance of the fair value, this dissertation closely integrates risk management and fair value accounting in order to provide a unified measurement framework when the markets are no longer active. This unified framework includes the unit of measurement for liquidity risk and credit risk, calculating and allocating of liquidity adjustments and credit valuation adjustments etc. When the markets are no longer active, this dissertation also studies the safeguarding mechanisms in order to ensure the reliability of the measurement of the fair value. This dissertation also emphasizes how to coordinate the differences between the accounting and prudential supervision from the perspectives as follows:the classification of the financial instruments, the impairments of the financial assets and the disclosure of risks. We suggest that the entity identify the management of the financial instruments, strengthen the linkage between the accounting classifications, the classifications of the prudent supervision and the management of the capital management; the entity also draw on the method of expected loss from the prudential supervision, for example, we can estimate the impairment of the accounting assets using PD, LGDAND EAD. The entity can absorb the experience of the prudential supervision in the accounting classifications, back-testing and stress-testing in order to improve the disclosing level of the risk and the measurement. For better coordination between the accounting and prudential supervision and meeting the different goals from the same information source (accounting information), The entity should integrate accounting, performance, and market data, integrate different risk models and risk evaluation process, and integrate risk management department and management accounting department. The entity should establish a comprehensive data platform, a unified method of risk measurement and risk evaluation process, and shape a consistent risk reporting system.The dissertation focuses on fair value accounting from the prudential supervision through normative analysis, empirical analysis, and case studies. The entity analyses and solves the financial stability through disclosing the accounting information (financial position, risk profiles, and the uncertainty of measures), so we achieve the expected goal.