Self-Determination of use of Market Value by Banks: Good or Bad?
As per the new Exposure Draft of FASB, financial institutions are now relaxed from the use of fair value in their financial statements. As per this new rule, if the bank intended to keep the asset until it was paid off, it would be carried on the financial statements at cost price, and the value will not fall or rise when the market prices are changed. The proposal was welcome by the banks which were once unhappy with the proposal of 2010 regarding use of market value as they(banks) contented that since market values of financial securities had depressed at the times of the financial crisis, it was not effective for them to use market values.
The new rules relating to use of Fair Value will be advantageous in ending the counterintutive practice of the bank’s profit, that rose when credit had worsened and subsequently fell when the credit is recovered. It will also add a greater amount of transparency in reporting of assets of the banks as unless the bank believed that the asset had become doubtful regarding recovery of the loan amount, only then the loan will be written down, by the amount of losses that the banks expect. Finally, this rule also facilitates the banks to report these assets on the basis of fair value only when it intends to sell these assets and if the bank is not sure of its intention to sell, it might still continue to write down or increase the value of the asset, but such gain or loss will be reported only under other comprehensive income and will not be a part of net income of the bank.
However, this new rule i.e, the one where banks are allowed to use market values when they seem just, has also been criticized on the basis that it would help the banks to avoid fair values for assets that they do not want to treat that way. In other words, at the time of 2007, when banks were required to adjust the value of their own liabilities based on market values. As a result, when the value of bonds issued by banks had decreased, banks immediately wrote down the value of the bonds and showing reduced amount of liability and an unhealthy increase in their net income. Later, when banks recovered during 2010, and so do their bonds, their debts were shown at higher amount. Thus, the biggest disadvantage of this new accounting rule is that banks can immediately adopt when to use and when not to use the market value at the time of financial reporting. Hence, with such lenient discretion available to banks, it is most possible that it would be difficult for the analyst to compare the financial statements of the companies and the banks
However, since these rules provides much needed transparency in relation to valuation of debts of the banks and propose not to include any changes in value of debts as part of Income Statement, they should be allowed to adope these new rules as it goes with the objective of FASB framework to ensure fairness and transparency in financial accounting.
