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  • 2022
  • Article
  • Journal of Financial Reporting

Regulatory Treatment of Changes in Fair Value and the Composition of Banks' Investment Portfolios

By: Michael Iselin, Jung Koo Kang and Joshua Madsen
  • Format:Print
  • | Pages:22
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Abstract

In their implementation of Basel III, U.S. bank regulators are again including changes in the fair value of available-for-sale (AFS) debt securities in Tier 1 capital, but only for the largest U.S. banks. This paper investigates a potential impact of expanding this regulation by examining bank investment decisions in the 1990's when changes in the fair value of AFS debt securities were included in regulatory capital for all banks. Using a matched sample difference-in-differences research design, we find evidence that low-capitalized banks reduced their investments in more volatile asset classes (e.g., corporate bonds, non-agency MBS) and increased their investments in less volatile asset classes (e.g., treasuries and municipal bonds) after changes in fair value were included in regulatory capital. We also find that low-capitalized banks change their holdings of these asset classes in the opposite direction after regulators subsequently excluded changes in fair value from regulatory capital. These findings inform regulators worldwide regarding a possible consequence of Basel III. We also contribute to prior research by suggesting that changes in maturity and credit risk around the passage of SFAS 115 (Beatty 1995; Hodder, Kohlbeck, and McAnally 2002) were partially obtained by changing the composition of asset classes within banks' investment portfolios.

Keywords

Fair Value Accounting; SFAS 115; Basel III; Governing Rules, Regulations, and Reforms; Banks and Banking; Debt Securities; Credit; Risk and Uncertainty; Investment Portfolio; Decision Making; Banking Industry; United States

Citation

Iselin, Michael, Jung Koo Kang, and Joshua Madsen. "Regulatory Treatment of Changes in Fair Value and the Composition of Banks' Investment Portfolios." Journal of Financial Reporting 7, no. 1 (2022): 123–143.
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About The Author

Jung Koo Kang

Accounting and Management
→More Publications

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More from the Authors
  • Gone with the Big Data: Institutional Lender Demand for Private Information By: Jung Koo Kang
  • Client Concerns about Information Spillovers from Sharing Audit Partners By: Jung Koo Kang, Clive Lennox and Vivek Pandey
  • The Harmonization of Lending Standards within Banks through Mandated Loan-Level Transparency By: Jung Koo Kang, Maria Loumioti and Regina Wittenberg-Moerman
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