The CFA Institute has released a new study that calls for enhanced loan disclosures in order to allow investors to compare the financial statements of banks more effectively.
The study is the second part of the CFA Institute study, “Financial Crisis Insights on Bank Performance Reporting,” which reveals systematic differences in disclosed loan fair values and impairments (write-downs) by banks in 16 countries across the US, Canada, the European Union, Japan and Australia.
The results reflect a varied range of impairment measurements that cannot be explained solely by differences in economic conditions across countries. As loans are an important component of bank balance sheets and a key risk, the report recommends improving loan-related disclosures to enhance bank transparency.
Part II of the study, “Relationship between Disclosed Loan Fair Values, Impairments and the Risk Profile of Banks,” found that loan impairment analysis across 16 countries, over time, contrasts in certain cases with a similar breakdown of credit default swap spreads. This, in part, reflects the credit risk of assets held and suggests an inconsistent application of impairments accounting standards.
“A sound banking system should be the bedrock of economic recovery, and continued efforts to enhance bank transparency are vital to restore investor trust and confidence in the finance sector,” said CFA Institute director of financial reporting policy Vincent Papa, who wrote the report. “The first part of our report emphasized the need to represent the economic value of bank financial assets and to reflect any write-downs on a timely basis in order to make financial statements more informative. In the second part, we focus on one of the most critical issues for investors: the comparability of information.”
The study makes three recommendations for accounting standard-setters, regulators and financial statement preparers in order to encourage more comprehensive and comparable bank reporting:
1. Enhanced loan fair value disclosures: To help investor makes appropriate analytical adjustments, for example, explaining why disclosed fair values that are determined from internal models differ from the amounts reported on balance sheet.
2. Enhanced loan impairments disclosures: To enable investors to have a greater understanding of the sources of differences in the impairments reported on financial statements.
3. Strengthened regulatory enforcement: To ensure consistency and comparability of reported financial statement line items and disclosed amounts.
“What is striking in our findings is that the valuation gaps (differences between disclosed fair values in the notes and what is reported on balance sheet) cannot be readily explained by the prevailing economic environment in different countries,” said Papa. “This suggests that inconsistently determined and incomparable information is reported by banks. There is clearly a need to enhance bank disclosures in order to help investors make like-for-like comparisons between banks. It also heightens the importance of an effective bank asset quality review by the ECB [European Central Bank] and other national regulators.”
The study findings align with the purpose of the CFA Institute’s Future of Finance initiative, which advocates greater transparency and fairness in pursuit of a stronger financial system. Part I of the study, "Assessing the Key Factors Influencing Price to Book Ratios," which evaluates loan impairments which have an effect on Price to Book (P/B) ratios, a key valuation measure of the financial soundness of banks, made three policy recommendations for accounting standard-setters, regulators, and financial statement preparers: fair value accounting for loans, support for enhanced risk reporting, and improved leverage reporting.
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