The Bank of International Settlements has issued a trio of working papers dealing with the impact of accounting changes on financial firms’ decision making.

On November 11-12 2005, the BIS held a workshop on accounting, risk management and prudential regulation, which brought together senior accounting practitioners, standard setters, finance academics, supervisors and central bank officials. The papers were presented at the workshop.

One study examines whether accounting changes result in changes in the economic behaviour of financial institutions. Specifically, it looks at banks’ response to recent changes in accounting for trust preferred securities that effect how these securities are reported in the balance sheet but do not change the calculation of Tier 1 capital.

Its results suggest that, “Accounting changes can lead to changes in banks’ economic behaviour even when the change in accounting does not affect regulatory capital calculations. This is consistent with bank managers acting as if they are concerned with the markets’ response to the numbers reported after the accounting change,” it says.

The other two papers both deal with issues of fair value accounting. One paper discusses some of the issues arising from the fact that “fair values” are not always easily defined or readily available. It concludes that the application of fair value for financial liabilities might present fewer complications if it is matched by similar valuation principles for financial assets.

The other identifies issues that bank regulators need to consider if fair value accounting is used for determining bank regulatory capital and when making regulatory decisions. “First, regulators need to consider how to let managers reveal private information in their fair value estimates while minimizing strategic manipulation of model inputs to manage income and regulatory capital. Second, regulators need to consider how best to minimize measurement error in fair values to maximize their usefulness to investors and creditors when making investment decisions, and to ensure bank managers have incentives to select investments that maximize economic efficiency of the banking system. Third, cross-country institutional differences are likely to play an important role in determining the effectiveness of using mark-to-market accounting for financial reporting and bank regulation,” it concludes.