Relationship loans and regulatory capital: why fair-value accounting is inappropriate for bank loans

Abstract

Banks have been required to report many securities and all derivatives at fair values under U.S. GAAP rules for many years. Soon, International Accounting Standards will provide some banks with a “fair-value option” for loans, also. A similar movement toward applying fair values to loans may occur in the U.S. in the near future, too. ; This paper argues that fair-value accounting is inappropriate for banks’ relationship loans from the standpoint of safety-and-soundness supervision—that is, for the purposes of calculating a bank’s regulatory capital. The argument is straightforward, although perhaps not obvious.Bank loans ; Bank capital ; Bank supervision