- Vincent Papa, PhD, CPA, CFA
- Sandra J. Peters, CPA, CFA
A feature of the financial crisis that begs for review is the sustained depressed price-to-book ratios (P/Bs) of many leading euro area and US banks. This study assessed P/B trends alongside the factors that we expected to influence this key valuation metric. We analyzed a global sample of 51 banks—mostly large, complex banking groups—over an 11-year span covering the periods before, during, and after the crisis. We found evidence of relationships between P/Bs and loan impairments, profitability, and risk. Our results show that the representation of loan impairments on balance sheet (allowance for loan losses) lags markets’ economic write-down of these loans. This finding signals the delayed recognition of loan impairments by the analyzed banks and justifies the efforts of accounting standard setters to ensure a more complete and timely recognition of financial asset impairments. It also highlights the importance of the ongoing asset quality review and emphasis on balance-sheet repair by the European Central Bank and national regulators.
Read part two of the Financial Crisis Insights on Bank Performance Reporting publication, “Relationship between Disclosed Loan Fair Values, Impairments, and the Risk Profile of Banks.”
- Admati, A., and M. Hellwig 2013 The Banker’s New Clothes: What’s Wrong with Banking and What to Do about It Princeton, NJ Princeton University Press
- Badertscher, B.A., J.J. Burks, and P.D. Easton 2012 A Convenient Scapegoat: Fair Value Accounting by Commercial Banks during the Financial Crisis Accounting Review Vol. 87 No. 1 January 32
- Badertscher, B.A., J.J. Burks, and P.D. Easton 2014 The Market Pricing of Other-Than-Temporary Impairments Accounting Review Vol. 89 No. 3 May 28
- Baginski, S.P., M.T. Bradshaw, and J.M. Wahlen 2011 Financial Reporting, Financial Statement Analysis and Valuation: A Strategic Perspective 7 Mason, OH Cengage Learning
- Bank of England 2012 Financial Stability Report No. 31 June
- Bank of England 2012 Financial Stability Report No. 32 November
- Barclays Equity Research 2013 European Banks: Eight Key Questions for 2013
- Barth, M., and W. Landsman 2010 How Did Financial Reporting Contribute to the Financial Crisis? European Accounting Review Vol. 19 No. 3 25
- Barth, M., W. Beaver, and W. Landsman 1996 Value Relevance of Banks’ Fair Value Disclosures under SFAS 107 Accounting Review Vol. 71 No. 4 October 25
- Barth, M., W. Beaver, and W. Landsman 2001 The Relevance of Value Relevance Literature for Accounting Standard Setting: Another View Journal of Accounting and Economics Vol. 31 No. 1 September 28
- Beaver, W., and M. Venkatachalam 2003 Differential Pricing of Components of Bank Loan Fair Values Journal of Accounting, Auditing & Finance Vol. 18 No. 1 January 27
- Beltratti, A., N. Spear, and M.D. Szabo 2010 The Value Relevance of Write-Downs during the Subprime Financial Crisis Working paper, Bocconi University and University of Melbourne
- Blankespoor, E., T.J. Linsmeier, K. Petroni, and C. Shakespeare 2012 Fair Value Accounting for Financial Instruments: Does It Improve the Association between Bank Leverage and Credit Risk? Working Paper
- CFA Institute 2009 International Financial Reporting Standards (IFRS) Financial Instrument Accounting Survey
- CFA Institute 2010 Survey on Financial Instruments
- CFA Institute 2011 User Perspective on Financial Instruments Risk Disclosures under IFRS
- CFA Institute 2013 Comment Letter on Financial Instruments: Expected Credit Losses (Impairments)
- CFA Institute 2013 Ethical and Professional Standards, Quantitative Methods and Economics CFA Program Curriculum 2014, Level II Vol. 1
- CFA Institute 2013 Survey on Expected Credit Losses (Impairments)
- CFA Institute 2014 CFA Institute 2014 Global Market Sentiment Survey
- CFA Institute 2014 Financial Crisis Insights on Bank Performance Reporting (Part 2): Relationship between Disclosed Loan Fair Values, Impairments, and the Risk Profile of Banks
- Credit Suisse 2011 European Banks—The Lost Decade
- Damodaran, A. 2009 Valuing Financial Services Firms Working paper NYU Stern
- Dermine, J. 2009 Bank Valuation: With an Application to the Implicit Duration of Non-Maturing Deposits Working paper, INSEAD
- European Central Bank 2010 Beyond ROE—How to Measure Bank Performance
- European Central Bank 2013 Financial Stability Review
- Financial Stability Board 2012 Enhancing the Risk Disclosures of Banks EDTF Report
- Georgescu, O., and C. Laux 2013 Financial Reporting, Financial Regulation, and Financial Stability Evidence from German Bank Failures in 2007–2008 Working Paper
- Goh, B.W., J. Ng, and K.O. Yong 2009 Market Pricing of Banks’ Fair Value Assets Reported under SFAS 157 during the 2008 Economic Crisis Working paper Singapore Management University and Massachusetts Institute of Technology.
- Hirst, D.E., P.E. Hopkins, and J.M. Wahlen 2004 Fair Values, Income Measurement, and Bank Analysts’ Risk and Valuation Judgments Accounting Review Vol. 79 No. 2 April 20
- Hodder, L.D., P.E. Hopkins, and J.M. Wahlen 2006 Risk-Relevance of Fair-Value Income Measures for Commercial Banks Accounting Review Vol. 81 No. 2 March 39
- International Monetary Fund 2013 Global Financial Stability Report—Transition Challenges to Stability
- J.P. Morgan Cazenove 2012 Financial Instruments Disclosure Analysis—2011 Annual Reports of 44 European Banks Examined in Detail
- Kennedy, P. 2003 A Guide to Econometrics 5th ed. Hoboken, NJ Wiley-Blackwell
- KPMG 2014 Reinvention of UK Banking: UK Banks: Performance Benchmarking Report Full Year Results 2013
- Laux, C., and C. Leuz 2010 Did Fair Value Accounting Contribute to the Economic Crisis? Journal of Economic Perspectives Vol. 24 No. 1 Winter 26
- Linsmeier, T.J. 2011 Financial Reporting and Financial Crises: The Case for Measuring Instruments at Fair Value in the Financial Statements Accounting Horizons Vol. 25 No. 2 June 9
- Liu, C.C., and S.G. Ryan 2006 Income Smoothing over the Business Cycle: Changes in Banks’ Coordinated Management of Provisions for Loan Losses and Loan Charge-Offs from the Pre-1990 Bust to the 1990s Boom Accounting Review Vol. 81 No. 2 March 21
- Mosso, D. 2010 Transparency Unveiled: Financial Crisis Prevention through Accounting Reform Accounting Horizons Vol. 24 No. 1 March 13
- Nekrasov, A., and P.K. Shroff 2009 Fundamentals-Based Risk Measurement in Valuation Accounting Review Vol. 84 No. 6 November 29
- Ötker-Robe, I., and J. Podpiera 2010 The Fundamental Determinants of Credit Default Risk for European Large Complex Financial Institutions IMF Working Paper WP/10/153 June
- Pae, J., D.B. Thornton, and M. Welker 2005 The Link between Earnings Conservatism and the Price-to-Book Ratio Contemporary Accounting Research Vol. 22 No. 3 Fall 25
- Partnoy, F., and J. Eisinger 2013 What’s Inside America’s Banks? Atlantic Magazine
- PricewaterhouseCoopers 2013 European Portfolio Advisory Group Market Update October
- R.G. Associates 2012 Fair Value Reporting: Surveying Financial Institutions at 1Q 2012. Analyst’s Accounting Observer Vol. 21 No. 10 March
- Schaffer, S 2010 Fair Value Measurement: Villain or Innocent Victim Working paper, Federal Reserve Bank of Boston January
- Stracke, C. 2012 Shine More Light: Enhanced Disclosures Can Help Investors and Security Prices PIMCO Viewpoint November
- Trott, E. 2009 Accounting for Debt Instruments Held as Assets. Accounting Horizons Vol. 23 No. 4 December 13
- Wooldridge, J.M 2002 Econometric Analysis of Cross Section and Panel Data Cambridge, MA MIT Press
- Yang, J., and K. Tsatsaronis 2012 Bank Stock Returns, Leverage and the Business Cycle BIS Quarterly Review March