Loan fair values and the financial crisis

Abstract

Purpose

In 2009, effective the second-quarter, the financial accounting standards board mandated that all banks need to disclose the fair value of loans in their 10-Q filings in addition to their 10-K filings. This paper aims to investigate whether these disclosures reduced the level of information asymmetry about the riskiness of bank loan portfolios during the financial crisis.

Design/methodology/approach

The paper examines the impact of these disclosures on the bid-ask spread of a panel of 246 publicly traded bank holding companies. The spread serves as a proxy for information asymmetry and the ratio of the fair value of a bank’s loan portfolio to its book value is a proxy for the credit and liquidity risk associated with the same. The reaction to the first-quarter filing serves as a control to assess the reaction at the time of the second-quarter filing.

Findings

There is a significant negative association between bid-ask spread and the ratio indicating that the fair value information was useful in reducing information asymmetry during the financial crisis. A pattern was observed in the information dissemination related to the fair value of loans that is consistent with the literature that documents a delayed investor reaction to complex financial information.

Originality/value

Investors may use the fair value information to better assess the risk profile of a BHC’s loan portfolio. Also, loan fair values provide managers with data to better implement stress test models and determine optimal capital buffers.

Citation

Chipalkatti, N., DiPierro, M., Luft, C. and Plamondon, J. (2020), "Loan fair values and the financial crisis", Journal of Risk Finance, Vol. 21 No. 5, pp. 559-576. https://doi.org/10.1108/JRF-04-2020-0081