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Banks’ Financial Reporting and Financial System Stability by Prof. Viral Acharya

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Vacharya_photoThe use of accounting measures and disclosures in bank contracts and in regulation suggests that the quality of banks’ financial reporting is central to the efficacy of market discipline and non-market mechanisms in limiting bank debt and risk overhang in good economic times, as well as mitigating the consequences of risk overhang that could compromise the stability of the financial system in downturns. Professors Viral Acharya and Stephen Ryan examine how research on banks’ financial reporting, informed by the financial economics literature on banking, can generate insights about how to enhance the stability of the financial system.

The researchers begin with a foundational discussion on how aspects of banks’ accounting for financial instruments, opacity and disclosures may affect stability. They then develop a simple model of fair value and amortized cost accounting with regulatory forbearance that illustrates the complex interactions that can result among banks’ accounting treatments, investors’ willingness to fund banks’ assets, the incentives of banks and investors to gamble, and regulators’ policy of bailing out banks. Next, the researchers evaluate representative papers in the existing empirical literature on banks’ financial reporting and stability, pointing out the research design issues that empirical accounting researchers need to confront to develop well-specified tests capable of generating reliably interpretable findings. The paper concludes with considerations for accounting standard setters and financial system policymakers. Professors Acharya and Ryan presented this paper at the 50th annual Journal of Accounting Research conference at Chicago Booth on May 8.

Read the full paper here.

–Krista Carver is the Assistant Director, MSRM, at NYU Stern School of Business

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