Accounting changes to increase volatility of bank stocks

Have the bean-counters thought through the consequences of proposed changes to accounting standards?

The Asian Wall Street Journal of October 12th carried an article buried in the inside pages about certain changes in accounting rules which could have significant impact on how banking is done. If these changes go through, banks stocks could be as volatile as technology stocks. They could also give a huge fillip to the trading of secondary market in loans.

It appears that the Financial Accounting Standards Board (FASB) and the International Accounting Standards Committee would require banks to "mark to market" their entire loan portfolio. Traditionally banks tend to carry their loan portfolio at cost, except under special circumstances such as their loan trading book, or for some banks where they have failed underwritings.

Needless to say the proposed changes are being denounced by banking associations globally. For once, even the regulators such as the U.S. Federal Reserve Board and the Basel Committee on Banking Supervision seem to have sympathy with the banks and question the viability of implementing such a system for financial portfolios running into hundreds of thousands of borrowers and loans running into trillions of dollars.

While there are probably a handful of banks with relatively small portfolios, including JP Morgan, which already resort to such valuations, most of the universe of banks globally do not. The implication of applying this accounting standards means that all commercial banks will effectively be treated/valued as investment banks due to the constant valuation of the portfolios.

The rationale for banks such as the major global banks to have a diversified portfolio of emerging and developed world loans will disappear, since the emerging market portfolio will by nature be more volatile. You might see a withdrawal of the international banks from the emerging markets and the drying up of liquidity in the countries which need them the most, since they are not able to access the capital markets.

This could have serious consequences which we hope that the members of the Accounting Standards Board have taken into consideration while sitting in their ivory towers and insisting on the implementation of these accounting policies.

The positive side is of course the need to allocate less capital. Also this will also lead to more liquidity in the markets and could lead to the development of a market which would be even bigger than the bond market. The people cheering the most and laughing all the way to their banks will be the rating agencies, the loan brokers and the internet portals which are being set up to trade secondary market loans – if they have pockets deep enough to survive the three years to five years before these accounting standards are implemented. Keep watching this space!

Mr Syn is a highly respected banker with years of experience in the Asian syndicated loan market.