CFA Institute Calls for Greater Transparency in Bank Reporting

A new study, Financial Crisis Insights on Bank Performance Reporting, suggests that better reporting of risk, timely loan write-downs on balance sheets, and investor access to comparable reporting of information across jurisdictions, will improve transparency and reduce investor risk aversion towards the banking sector. 

Part 1 of the report, Assessing the Key Factors Influencing Price to Book Ratios, evaluates loan impairments which have an effect on Price to Book (P/B) ratios, a key valuation measure of the financial soundness of banks. The study, based on data from 51 major global banks, evaluates P/B trends from 2003 to 2013 and assesses how loan impairments measures, profitability measures, and risk measures, have affected P/B throughout this reporting period. 

Vincent Papa, CFA, director of financial reporting policy at CFA Institute and author of the report, commented:

“A vibrant, well-functioning banking sector is crucial for overcoming the ongoing economic malaise that continues to affect developed world economies. This report focuses on the relationship between market-based indicators of value and risk and bank financial statement information, to reveal fault lines within the reporting framework. When signals from the economic environment do not correspond with signals from bank financial reports, investors’ ability to discern the economic reality from financial statements is limited. 

“Banks are opaque to many external stakeholders, including the investors upon whom they rely for both equity and debt capital, and the financial crisis presented a clear opportunity for enhancing bank transparency. In this study, we consider the reforms by accounting standard setters and regulators, and bank performance reporting before, during and since the pinnacle of the financial crisis, in order to identify where continued efforts to improve bank transparency are required.”

Part 1 of the study makes three policy recommendations for accounting standard setters, regulators, and financial statement preparers:

1. Accounting for loans – fair value recognition and measurement: The report suggests that fair value recognition presents the most up to date information and allows for a timely reflection of changes to the economic value of loans, contending that in the long run it is desirable to have both fair value and amortised cost for loans included in financial statements. 
2. Support for enhanced risk reporting: This is necessary to reduce investor risk aversion towards banks as they grapple with bank business models and underlying risk exposures. This recommendation was also put forward by the FSB-Enhanced Disclosure Task Force (EDTF).
3. Improved leverage reporting: There is a need for comparable measures of total assets for banks across jurisdictions to allow for a comparison of accounting leverage (assets/equity) which in turn will enable a better understanding of risk signals.

Kurt Schacht, CFA, Managing Director, CFA Institute, commented: “This study brings to the fore one of the most challenging issues facing banks today. The findings align strongly with the purpose of our Future of Finance initiative, which advocates greater transparency and fairness in pursuit of a stronger financial system.”

Part 2 of the report, Relationship between Disclosed Loan Fair Values, Impairments and the Risk Profile of Banks, will be released on 7 August 2014 and will provide a cross country analysis of trends in asset quality and carrying value of loans before, during, and after the financial crisis.

The to papers forming the report are based upon a review of financial reporting data from 2003 – 2013, from 51 large, complex banking groups from 16 leading economies across the EU, the US, Canada, Australia, and Japan. The sample includes 75% of the banking groups identified by the European Central Bank in its 2013 Financial Stability Report.