The first step in the reform of U.S. “fair value” accounting standards was just passed by the Financial Accounting Standards Board. This step eases requirements that banks to value illiquid assets at current prices, allowing them to reduce their losses on paper. Instead, banks will be able to use things like expected cash flows to calcuate the value of the so-called toxic securities.
The five-member accounting board is meeting at its headquarters in Norwalk, Connecticut. The board will vote on further changes later this morning.
There’s a lot of confusion about what these changes will mean for banks. Here’s what they won’t do: affect investor or analyst views of bank solvency. Numerous studies have shown that accounting rules have little effect on investor behaviour, since investors ignore accounting valuations and make independent judgments about assets on balance sheets.
But this doesn’t mean that allowing banks to boost the value of the assets on their books, or at least maintain current levels despite further market deterioration, won’t make a difference. What is really happening is that the rule changes create a form of regulatory forebearance. Banks will now find it much easier to meet regulatory capital and reserve requirements, lowering the chance that they will need to raise new capital to meet regulators demands.
So while the reforms won’t make banks any healthier, they will hold off regulators. This should be a postive for banks that investors believe are not in danger of failing–either because they are too big to fail or healthy enough to survive. The danger of a dilutive capital raise to meet regulatory requirements will be diminished.