MANAMA: The second part of a CFA Institute study titled ‘Financial Crisis Insights on Bank Performance Reporting’ revealed systematic differences in how banks disclose fair values of loans and write off bad or “impaired” debt in 16 countries across the EU, the US, Japan, Canada and Australia.
The results reflected a disparate range of impairment measurements that cannot only be explained by differences in prevailing economic conditions, and 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.
The CFA study called for 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.
It also recommended for enhanced loan impairments disclosures enabling investors to have a greater understanding of the sources of differences in the impairments reported on financial statements.
The study author’s believe that by strengthening regulatory enforcement would ensure consistency and comparability of reported financial statement line items and disclosed amounts.
“Negative valuation gaps (where disclosed fair values in the notes are greater than the loan carrying value reported on the balance sheet) were prevalent amongst banks in France, Spain, Italy, Switzerland and the Netherlands. This is in contrast to the positive valuation gaps observed in German and UK banks,” study revealed.
“A valuation gap ranging from -30% (six year average) for Spanish banks through to 24% for UK banks (see table A). This gap could not be explained on the basis of prevailing economic conditions during the financial crisis, or bank-specific risk as reflected in Credit Default Swap (CDS) spreads and Price-to-Book ratios.
“Loan impairment analysis across 16 countries, over time, contrasts in some cases with a similar analysis of CDS spreads, which in part reflects the credit risk of assets held. This suggests an inconsistent application of impairments accounting standards.”
The study makes three recommendations for accounting standard setters, regulators, and financial statement prepares in order to aid more comprehensive and comparable bank reporting.
“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,” Vincent Papa, CFA, director of financial reporting policy at CFA Institute and author of the report, said.
“The first part of our report emphasised 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.”
“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. 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 and other national regulators.”