Economic Consequences of Fair Value Reclassifications of Financial Assets According to IAS 39

An Emprical Analysis

Master's Thesis, 2015

106 Pages, Grade: 2,0


Table of contents

List of abbreviations

List of symbols

List of figures

List of tables

List of appendices

1 Introduction

2 Theoretical Framework
2.1 IAS 39 – Financial Instruments: Recognition and Measurement
2.2 IAS 39 and IFRS 7 Amendments: The Reclassification Option
2.3 Bank’s Regulatory Capital
2.4 Reclassification Consequences for Bank’s Financial Statements
2.5 Related Literature
2.6 Fair Value Hierarchy of Financial Assets

3 Data and Statistics
3.1 Data Sources and Sample Selection
3.2 Definition of Variables
3.3 Sample Characteristics and Representativeness
3.4 Testing the Theoretical Predictions
3.4.1 Correlation Tests
3.4.2 Causality Tests Theoretical background Logit Model Linear Regression

4 Critical Appraisal

5 Conclusion



List of abbreviations

illustration not visible in this excerpt

List of figures

Figure 1: Use of the Reclassification Option in 2008

Figure 2: Fair Value Hierarchy 2007-2012

Figure 3: Scatterplot 1 for Reg Model 1

Figure 4: Scatterplot 2 for Reg Model 2

Figure 5: Scatterplot 3 for Reg Model 3

Figure 6: Scatterplot 4 for Reg Model 4

Figure 7: IAS 39 – Financial Instruments: Recognition and Measurement of Financial Assets VII

Figure 8: Appendix: Share of GIIPS – government bonds each category X

List of tables

Table 1: Fair Value Hierarchy

Table 2: Reasons for excluding banks

Table 3: Definition of Variables

Table 4: Statistics on the Use of the Reclassification Option

Table 5: Correlation coefficients with Reclas and Reclas amount

Table 6: Correlation coefficients without disclosure variable

Table 7: Correlation coefficients of Reclassified Banks n = 92

Table 8: Overview of all significant variables for Reclas amount

Table 9: Overview of all significant variables for Dummy Reclas

Table 10: Logit Model 1

Table 11: Logit Model 2

Table 12: Model 1 reg Reclas amount ~ Tier1 capital ratio if Reclas = 1

Table 13: Breusch-Pagan Test for reg Model 1

Table 14: Model 2 reg Reclas amount ~ Variables in literature if Reclas = 1

Table 15: Breusch-Pagan Test for reg Model 2

Table 16: Model 3 reg Reclas amount ~ Level1 Level2 Level3 if Reclas = 1

Table 17: Breusch-Pagan Test for reg Model 3

Table 18: Model 3 reg Full Model

Table 19: Breusch-Pagan Test for reg Model 4

Table 20: Amendment IAS 39 and IFRS 7 in comparison with US GAAP

Table 21: Orbis search strategy

Table 22: Country list of the initial sample of 297 banks

Table 23: Main exchanges

Table 24: Country list of the final sample with 255 banks

Table 25: Bank names of final sample

Table 26: Exchange rates Orbis 2008

Table 27: List of banks with low disclosure quality

Table 28: Descriptive Statistics

Table 29: Descriptive Statistics of (a) Reclassifying Banks

Table 31: Descriptive Statistics of (b) Non-Reclassifying Banks

Table 32: Correlation matrix – all variables (n = 255)

Table 33: Correlation matrix – disclosure variable (n = 208)

Table 34: Correlation coefficients only Reclassified Banks (n = 92)

List of appendices

Appendix 1: IAS 39 – Financial Instruments: Recognition and Measurement of Financial Assets

Appendix 2: Amendment IAS 39 and IFRS 7 in comparison with US GAAP

Appendix 3: Prudential Filters as per the Consolidated Financial Statements Reconciliation Regulation

Appendix 4: Importance of CDS Spreads

Appendix 5: Share of GIIPS – government bonds each category at the reporting dates 2010 and 2011

Appendix 6: Orbis search strategy

Appendix 7: Country lists of the sample

Appendix 8: Bank names of final sample

Appendix 9: Exchange rates Orbis 2008

Appendix 10: List of banks with low disclosure quality

Appendix 11: Descriptive statistics of the entire sample XX

Appendix 12: Descriptive Statistics of (a) Reclassifying Banks & (b) Non-Reclassifying Banks

Appendix 13: Correlation matrix – all variables (n = 255)

Appendix 14: Correlation matrix – disclosure variable (n = 208)

Appendix 15: Correlation matrix – dummy Reclas (n = 92)

Appendix 16: Logit Model 2 without the variable ROE

Appendix 17: Full Model: Logit Reclass ~ all variables

Appendix 18: Overview of the Logit models

Appendix 19: Tests for Multicollinearity – VIF tables

1 Introduction

After the development of the International Financial Reporting Standards (IFRS) by the International Accounting Standard Board (IASB) in 2001, the European Union (EU) decided to unify the jurisdictions for all listed corporations and therefore decreed a mandatory adoption of IFRS in the EU.[1] The EU reasoned that common accounting standards improve capital market efficiency and reduce information processing and auditing costs.[2] However, the decisive reason for the adoption of IFRS was that today’s global economy requires global standards to ensure transparency, accountability and comparability of financial accounts. IFRS was preferred because of its focus on a fair value-based method of accounting compared to historical cost accounting, and the EU claimed that adopting IFRS would bring financial stability while serving the interests of the public.[3]

Regulators favor the use of fair value accounting (FVA) in financial reporting, specifically in the area of financial instruments, to perform a current market valuation. At least, this was the case before the credit market turmoil in 2008. The management teams of many financial institutions complained about the accounting standards and argued that the fair value method would prevent an improvement of financial stability. Critics go so far as to claim that FVA contributed to the worst economic crisis since the Great Depression in the United States (US) following the subprime crisis.[4] As a result, FVA was a major issue in policy debates during the financial crisis in 2008.

Neither the IASB nor the Financial Accounting Standards Board (FASB) agreed to change the fair value regime; however, both regulatory bodies arrived at the conclusion that they had to relax the fair value requirements for financial assets. After intense political pressure, the IASB announced the Amendment to IAS 39 and to IFRS 7 in October 2008, which permitted the reclassification of certain financial instruments from the fair value category to the amortized cost category and required additional disclosures with respect to reclassification practices.[5] These amendments were issued fairly rapidly to address the prevailing market conditions and because banks argued that FVA was forcing them to report potentially excessive losses due to the circumstances of the crisis.

Advocates of FVA meanwhile strongly disagreed that the change to mark-to-market accounting was responsible for the crisis and argued that every regulatory change has economic effects.[6] Depending on the class of asset and country-specific capital regulations, these losses would have otherwise been included in a bank’s regulatory capital. Thus, the choice to reclassify could protect a bank’s regulatory capital against a further decrease during the crisis.[7] So, the amendment was aimed at reducing the pro-cyclical character of FVA, but at the same time it hid the amount of write-downs and violated the transparency factor. The Center for Financial Integrity consequently commented that relaxing FVA would lead to less timely and hence less informative disclosures about banks’ financial solvency and therefore extend the duration of the financial crisis.[8] Ball said in 2008: “Abandoning fair value accounting is equivalent to ignoring market prices.”[9] As a result this ad-hoc change implied a trade-off between financial stability and transparency.

The purpose of this thesis is to provide direct empirical evidence on the use of the Amendment to IAS 39 regarding the reclassification of financial instruments. It therefore reviews what happened when the accounting policies were switched from fair value accounting to historical accounting during the financial crisis in 2008. Using a sample of manually collected data from Western European banks, the thesis empirically examines which banks used this reclassification option to deal with problematic financial assets and how these reclassification activities are correlated with other firm characteristics. Furthermore, the thesis shows the influence of the amount of assets in each fair value level on the fair value hierarchy and the impact of the banks’ regulatory capital during the height of the financial crises on the use of the relaxation option. The final aim is to analyze the economic consequences of this option and to determine how beneficial it is for the global financial system, considering that banks will again make use of this sort of permission in other, future crises.

2 Theoretical Framework

2.1 IAS 39 – Financial Instruments: Recognition and Measurement

Since its release in 1998, IAS 39 has undergone continuous changes: in total, 12 amendments and revisions have been published since the release.[10] It is a standard currently under review, as it has historically been considered to be confusing and to lead to misunderstandings. The original IAS 39, prior to the Amendment of October 2008, came into effect in 2005 with the aim of instituting a higher degree of transparency and consistency in financial instruments reporting. The initial recognition of financial assets is important for the initial and subsequent measurement as well as for the recognition of gains or losses. The initial measurement states the amount at which the financial asset is recognized in the financial statements at its acquisition, whereas subsequent measurement pertains to the carried value of the financial asset in the financial statements after its recognition.[11]

The original standard classifies financial assets into four main categories.[12] The first category includes assets at Fair Value through Profit or Loss (FVTPL); according to this category, these are assets that are either classified as Held for Trading (HFT) or are designated by the entity as at FVTPL upon initial recognition. All derivatives fall into this category. IAS 39 requires these assets to be measured initially and subsequently at Fair Value and that gains or losses then be reported in the Profit and Loss (P&L) statement. The second category is Held to Maturity (HTM) financial investments, which are non-derivative financial assets with determinable payments and a fixed maturity; the intention is thereby to hold the assets until maturity.[13] The third category is Loans and Receivables (L&R), which are also non-derivative financial assets with determinable payments but are not quoted in an active market; apart from those that an entity intends to sell immediately or in near future, these financial assets will be held for trading purposes.[14] The last category is Available-for-Sale (AFS) financial assets and includes non-derivative financial assets designated as available for sale or financial assets that are not classified in the other three categories.[15]

The last three categories are initially measured at Fair Value including transaction costs. However, HTM and L&R are measured after the first period at Amortized Costs using the effective interest method. Lastly, the AFS category should be measured subsequently, at Fair Value, with the exemption that investments in equity instruments, such as shares, have no reliable fair value measurement. These equity investments are measured at acquisition costs. Gains and losses from the financial assets in the HTM and L&R categories are also accounted in Profit or Loss.[16] However, gains and losses from the financial assets in the AFS category are recognized to other comprehensive income (OCI).[17] The recognition of gains and losses from the OCI are reported later in Profit or Loss; this process is called “Recycling”.[18] De-recognition of financial assets is discussed extensively in IAS 39 and is extremely controversial. Before the amendment was published, IAS 39 prohibited the reclassification of financial instruments into or out of the FVTPL category.[19]

In the context of the overall debate surrounding the financial crisis, the history of this standard, and the differences between the European and American regulations, the IASB and the FASB worked on a joint project to create a uniform classification and measurement of financial instruments. The IASB published a new exposure draft in July 2009 on financial instruments, IFRS 9, with the aim of ultimately replacing (though not completely) IAS 39 by the year 2018. Given this thesis’ focus of the reclassification option, IFRS 9 is not within the scope of this analysis. The reclassification option, as discussed here, will no longer exist in IFRS 9.[20]

2.2 IAS 39 and IFRS 7 Amendments: The Reclassification Option

On October 13, 2008, the IASB issued amendments to IAS 39 Financial Instruments: Recognition and Measurement and IFRS 7 Financial Instruments: Disclosures that would permit the reclassification of some financial instruments. These amendments announce the possibility of reclassification for companies applying IFRS. The American generally accepted accounting principles (US GAAP) already permitted this in ‘rare’ circumstances. Banks could apply the option retrospectively, effective on July 1, 2008.[21] Entities are allowed to retroactively reclassify financial assets previously recognized at fair value into categories that require a measurement at amortized costs or at fair value through OCI and to disclose their unrecognized fair value changes in footnotes.[22] The decision followed intense pressure from politicians and banking regulators, mainly in Europe.[23] The Institute for International Finance (IIF) sent a draft to US and European central banks, governments, and regulators for an urgent reform of accounting standards. Pursuant to the draft, an intervention by the regulatory bodies would be essential to avoid the high losses on financial instruments incurred due to the required fair value measurement.[24] At the height of the crisis, G7 members also came to the conclusion that the IASB should bring out an amendment by the end of October to support their banks and prevent a competitive disadvantage for European banks against US banks.[25] The decline in the global financial markets that occurred during the second half of 2008 is an example of ‘rare’ circumstances cited in the IFRS amendments and therefore justified its publication.[26]

Concerning the Amendment to IAS 39, the FASB allowed reclassification out of the fair value category into the historical cost category. As long as they had the will and ability to hold the assets to maturity, banks were allowed to reclassify financial assets from the trading assets and AFS categories to the HTM and L&R categories, as well as from trading assets to AFS. Assets under the fair value option and derivatives were excluded from this reform.[27]

Five types of reclassifications have various accounting consequences. The first alternative is the reallocation of financial assets from the trading category into the HTM or L&R category that affect net income and equity, if no impairment is activated, and regulatory capital.[28] Secondly, reclassifications from the trading category to the AFS category touch only net income, not equity. Next, reclassification of assets from the AFS category to the L&R or HTM category affects equity and regulatory capital but not net income.[29]

Unlike US banks, European banks used the reallocation option widely.[30] A possible reason for this is that the relaxation of fair value assets was new for European banks, while US GAAP already had the reclassification option under rare circumstances. However, the decisive criterion and the big advantage for European banks over US banks was the opportunity to reclassify retrospectively. The table in Appendix 2 shows that the amendments reduced differences between IFRS and US GAAP in a manner that yields quality financial information for market participants across the global capital markets.[31] Before October 2008, the reclassification option did not exist under IFRS.[32]

In summary, the October 2008 amendments to IAS 39 are only applicable for financial assets that are not designated at fair value through profit or loss upon initial recognition, non-derivative, and the category criteria, which are mentioned above. The amendment to IFRS 7 mandates the disclosure of both qualitative and quantitative information. This means on the one hand the information about the reason for reclassification, so the description of the rare situation, and on the other hand the statement about reclassification amounts and resulting accounting consequences. At best, a third party is able to examine the balance sheet and income statement to compute the effect of the reclassification with these disclosure requirements if the bank made use of the option.[33]

2.3 Bank’s Regulatory Capital

In today’s global marketplace, financial institutions have greatly expanded the scope of their activities. However, banking problems still plague many European countries; moreover, hundreds of systemic banking crises have devastated economies around the world since 1970.[34] In response to the global financial market’s growing complexity and the lack of transparency, the regulation and supervision of banks has had to change and has improved over the years.[35]

The purpose of regulation is to ensure that the equity capital a bank retains is sufficient to cover the risk it takes. The purpose is not to eliminate risk altogether, as this is impossible given the nature of the banking business; rather, governments want to minimize the probability of default and thereby increase confidence in the banking system, which is essential for a stable economy.[36] A prime concern of governments is systemic risk, which is the risk that a default by one bank could create a ‘domino effect’ that affects other banks and leads to defaults, thereby threatening the stability of the whole financial system. If governments allow one bank to fail, they thus put the financial sector at risk; however a bank bailout could also send incorrect signals to the investors, removing their incentives to control their own risks. Large banks will take on risk without proper insurance, thinking that the government will always bail them out because they are too big to fail.[37] As was observed during the market turmoil of 2007 and 2008, allowing Lehman Brothers to fail made the credit crisis worse, but it simultaneously led to banks becoming more cautious in their lending and to regulatory bodies being more careful in their monitoring.[38]

However, regulation does not affect all banks equally. Even within the same region, the European economic area, different laws and regulations by national and local governments define policies regarding bank capital standards, bank ownership restrictions, and loan provisioning standards.[39]

Capital regulation represents the backbone of banking sector policies. The risks include market risk, credit risk, and operational risk. A part of equity capital is identified as Tier 1 Capital (going-concern capital); subordinated long-term debt is classified as Tier 2 Capital (gone-concern capital). The amount of the capital that banks must hold is determined by the ratio of capital to total risky assets. Capital Tier 1 consists of Common Equity Tier 1, which must equal at least 4.5 % of risk-weighted assets at all times, and Additional Tier 1 Capital, which has to cover at least 6.0 % of risk-weighted assets at all times. The Basel Committee on Banking Supervision accordingly required a total Capital that is at least 8.0 % of risk-weighted assets at all times, with at least the half of the required capital being in Tier 1.[40] The calculation of risk-weighted capital and the requirements of the bank supervisors vary by country. In addition to the minimum capital ratios, the extent prudential supervision and regulatory capital are linked to financial reporting.[41] As discussed above, the impact depends on country-specific regulations. Unrealized gains and losses from trading assets are reflected in Tier 1 Capital through retained earnings, because unrealized gains and losses on trading securities are put in the income statement (similar to realized gains and losses). Unlike available-for-sale securities, trading securities are intended to be traded frequently, within days or weeks.

If these unrealized fair value changes after the reallocation date do not cause an impairment write-down in the reallocated category, for example in AFS, L&R or HTM, then the reclassifications from the trading category affect a bank’s Tier 1 capital.[42] A cross-country comparison is difficult because of the treatment of unrealized gains and losses from AFS assets. These are realized in OCI if the fair value losses do not result in an impairment write-down.[43] This simply means that reclassification affects regulatory capital in the scale of the accumulated unrecognized fair value gains before the reclassifications are considered in Tier 1 or Tier 2 capital. The extent of the impact depends on the prudential filter for cumulated gains of AFS debt securities, which is country-specific.[44] In 2007, the Committee of European Banking Supervisors (CEBS) prepared a revised analytical report on the implementation of the CEBS guidelines on prudential filters for regulatory capital to ensure consistent prudential regulation and supervision inside the European banking sector.[45] The purpose of the CEBS guidelines is to improve the definition and quality of regulatory capital for institutions using IFRS for prudential reporting. The objective of the prudential filters is thereby to be able to determine the level of equity at prudential level independently of the appropriate financial accounting approach taken.[46] Appendix 3 contains a more detailed overview of prudential filters and the adjustments of the equity under IFRS when determining the regulatory Tier 1 and Tier 2 capital. So, the prudential filter is enabled to absolutely or partially exclude those AFS revaluation reserves through OCI from regulatory capital according to specific criteria. On the individual level, the filter is applied to each instrument, while on the portfolio level the net reserves for the portfolios of equity securities, debt securities, and loans are relevant for the filter.[47]

To sum up, the higher the filter is (percentage rate that is deducted from accumulated gains or losses of AFS assets), the lower is the regulatory advantage of a reclassification during a market decline when asset fair value decreases. A prudential filter of 100 % for the reclassification would be unnecessary for the regulatory capital, whereas a filter of 0 % would be highly advantageous by avoiding a capital loss.[48]

Finally, the regulatory capital impact of IAS 39 reclassifications depends on the practicability of the IFRS group accounts for the measurement of regulatory capital. The request to disclose the option is stated in IAS 1. For the financial institutions, the regulatory effect is identical to a 100 % prudential filter applied to accumulated fair value gains and losses.[49] The prediction here is that if a bank confronts the risk of facing regulatory costs, which arises if the bank holds a low regulatory capital ratio, then the probability of using the reclassification option is high. The idea behind this is to increase regulatory capital during a financial crisis through reclassification.

2.4 Reclassification Consequences for Bank’s Financial Statements

Banks’ profits or losses are based on their financial activities. For a correct reporting, banks distinguish between the banking book and the trading book. In the former, profits are derived from the spread between the rate they pay for funds and the rate they receive from borrowers. Banks simply act as intermediaries of interest paid and interest received and take on the risks of offering credit. Loans made to corporations and individuals are not measured at current market prices. Therefore, as financial intermediaries, banks assume two primary types of risk: interest rate risk and credit risk.

The trading book includes all the contracts the bank enters into as part of its trading operations. The values of these assets and liabilities are marked to market daily.[50] This implies that the value of the book reflects changes in market prices and thus trading book profits depend mainly on the market. So, if the economy follows an upward trend the value of the assets increases and if the economy weakens the value decreases.

The crisis that shook financial markets at the end of 2007 continued into 2008, reaching an enormous scale in the final quarter of the year. This had an intense effect on the financial sector. The effects were particularly visible in the liquidity scarcity in numerous markets and market segments which did away with almost all reliable market transactions or reference points for a large number of financial instruments.[51] These exceptional circumstances prompted numerous banks to change their accounting treatment of financial instruments initially held for trading. The governments and central banks of every affected country have had to coordinate with each other to support the global financial system and provide substantial fiscal and monetary stimuli to counter the sharp economic downturn.[52]

Fiechter (2011) examined the influence of this controversial amendment on the 2008 financial statements of 219 European banks that apply IFRS. The author discovered that some of the sampled banks had taken extensive advantage of these reclassification opportunities. His findings revealed a substantial effect on these banks’ financial statements.[53] The effect of reclassifications on a firm’s future income and equity depends on the impairment rules under IAS 39. These rules regulate which fair value changes continue to be shown in net earnings and in equity for AFS assets, and also for assets identified at amortized cost.[54] In accordance with the standard, impairment losses should be recognized as soon as they are incurred, rather than when they are expected.

The rules of the impairment test require objective evidence linked to a specific event, for example a significant change in the credit rating or an actual default; the loss should not be temporary.[55] This means in effect that a decline in fair value does not necessarily lead to an impairment write-down, which is recognized in profit or loss. After recognizing that evidence of an object for impairment exists, the impairment loss should be calculated. The impairment loss amounts are dependent on the valuation category. For the AFS category the impairment loss is the difference between acquisition cost and fair value for the appropriate financial assets. For the categories HTM or L&R instruments, it is the difference between carrying amount and present value of estimated cash flows using the effective interest rate model. The estimated cash flows include incurred losses but not complete expected losses.[56]

As a result, reclassification of financial assets affects net income and shareholders’ equity only if the fair value decrease happens without an impairment being triggered. An impairment write-down will only acquire the amount of the fair value decline that results from incurred losses but not those that result from changes in discount rates or from changes in expectations about future losses when the asset is reclassified into the HTM or L&R category from the AFS category.[57] Since a change in the market value of a financial asset is treated separately for each category, the categorization of the asset define the impact on the balance sheet and income statement of the institution.[58]

In this thesis it has been assumed for the sake of simplification that the reclassification reduces losses and therefore affects the financial statement. As mentioned in section 2.3, the requirement for disclosure of the bank’s finances plays an important role for banks that trade on the public market and for auditors. The standard requires disclosure of the use of the reclassification and of the reclassification amount as well as of resulting accounting effects. The consequence here is that a bank’s decision regarding reclassification is simply a decision between publishing fair value information in the footnotes and recognizing changes in profit or loss or in OCI.[59]

2.5 Related Literature

The aim of the ad-hoc changes to accounting rules has been interpreted as a commitment by politicians, regulators and standard setters to support financial stability during financially distressed periods. Therefore, many authors have assessed the benefits and costs of the Amendment IAS 39 and examined the role of mark-to-market accounting in the financial crisis using descriptive data and empirical evidence. General findings show that the new amendment helped the banks in the worsening conditions and avoided further impairment losses which may have greatly increased the severity of the financial crisis.[60]

The study by Bischof, Brüggemann, and Daske (2014) is probably the most comprehensive study on this topic. Their sample includes 302 publicly listed banks reporting under IFRS. The authors show that banks used the reclassification option to renounce the recognition of fair value losses and ultimately regulatory costs from regulatory interruptions, due to the link between fair value accounting and regulatory capital.[61] The authors used the event study methodology, setting the first public announcement about the bank’s reclassification choice as the time when the event took place. They observed a positive stock market reaction around the announcement of the new accounting option.

The likelihood of reclassification was significantly high, particularly for banks with the greatest need for regulatory capital. Therefore the relation between a bank’s regulatory capital and the choice of reclassification should be negative, which indicates that the willingness to reclassify is higher when a bank’s regulatory capital is low. For financially strong banks the authors were expecting low chances for reclassifications; however, they found that even strong banks made use of reclassification, which led to abnormally high stock returns. The returns increased especially around the time of the announcement of the Amendment to IAS 39.[62] Therefore a clear treatment if banks with lower regulatory capital used the reclassification option more often is disputed in literature. Furthermore, the authors noticed a positive link between banks’ bid-ask spreads and the reclassification choice for those banks that did not provide full IFRS 7 disclosures about the unrecognized fair value changes.[63]

However, Georgescu (2014) criticized the study because bond prices or credit default swap (CDS) spreads were not included in the analysis, and therefore the study does not separate the incentives of equity and bond holders.[64] Credit derivatives are important instruments in financial markets and were debated at length among scholars, regulators and market participants during the financial crisis. They allow companies to trade and take care of credit risks in much the same way as market risks. The most attractive credit derivative is a CDS.[65] Except for the statistical method, this thesis is mostly based on the studies by Bischof, Brüggemann, and Daske (2014) and Georgescu (2014). In contrast to the study of Bischof, Brüggemann, and Daske, the author Georgescu considered in her study the difference in reaction of bond and equity markets. She analyzed the role of FVA during the 2007-2008 turmoil and the effects of a switch in the valuation of financial assets at the height of the crisis. The market reaction was tested in an event study setting for stock, bond and CDS prices.[66]

Georgescu finds some evidence that credit and equity market participants had contrasting views on the extent that the initiation of the reclassification measure facilitated problems caused by FVA; however, the results are not convincing.[67] In the context of an event study, the author used October 13 as the event date for the market-wide event study, similar to Bischof, Brüggemann, and Daske (2014).[68] The sample includes banks from Western Europe and only consolidated IFRS bank data. After excluding some banks because of insufficient data, the author reduced the initial sample of 454 Western European banks to a sample of 176 banks. 95 of those 176 banks chose to reclassify. The net income effect of the reclassification was significantly high, approximately € 309 million, which amounts on average to 57 % of the net income in 2008.[69] Banks reclassified around 29 % of the fair value assets on their balance sheets. Overall Georgescu reached the conclusion that the evidence on the direction of the trade-off between financial stability and transparency implied by the reclassification measure is contradictory.[70] This should serve to caution regulators that ad-hoc changes in the measurement regime at the height of a confidence crisis do not automatically achieve financial stability.

So, when the information through the CDS markets is essential for financial institutions to survive and the reclassification option contributes to financial stability, as mentioned in the existing literature, then there could exist a direct connection between the use of the reclassification option and the CDS spreads. This paper therefore predicts a negative CDS spread during a crisis but a positive correlation between the CDS spread and the reclassification option. In addition, Georgescu states that the reclassification option could reduce balance sheet contagion via amortization.[71] Therefore this thesis also predicts a positive connection between the accounting write-downs and the reclassification choice.

Early in 2012, Guo and Matuvo found that the banks that ratified the reclassification chance took advantage of the positive effects on profits, however the positive impact on shareholder equity were not as significant. The empirical results showed that the banks that did not adopt the option were characterized by a higher Return on Equity (ROE) compared to the banks that had made use of reclassification.[72] The prediction here is therefore that the higher the ROE, the less likely the bank is to reclassify; therefore, the relation is expected to be negative. The authors noticed that the region, a non-financial factor, was the most significant determinant to apply the reclassification option. Nevertheless, a direct comparison is difficult to make because of the discrepancies in the disclosure requirements between the different regions.[73]

Bowen, Khan, and Urooj (2014) examined stock market and credit market reactions to policy deliberations and decisions related to FVA and impairment rules during the financial crisis. Overall their stock market results suggest that investors acted as if the potential negative effects of then-existing FVA and impairment rules outweighed any benefits associated with having more time and hence more transparent mark-to-market data for decision-making.[74] Furthermore, they found robust evidence of the magnitude of stock price reactions to the relaxation of FVA and impairment rules being positively related to the proportion of banks’ illiquid assets.[75] So, this could imply that liquidity plays a role in the choice of reclassification. Therefore it is predicted that banks with higher cash reserves are less likely to use the reclassification option, so a negative relation is expected.

Jarolim and Oeppinger (2013), unlike the previously cited researchers, examined the importance of the reclassification option after the high point of the financial crisis, rather than during the crisis. Their focus was therefore on identifying the reasons for the application of reclassifications from 2009 to 2011 on the basis of the reclassified banks in 2008. The banks included in this study were based solely on their membership in the STOXX Europe Total Market Index (TMI), but only 64 banks from the index are considered. Various banks were excluded because of several reasons, primarily due to the lack of available data. Of the remaining sample, 46 banks reported that they used the reclassification option and the rest consciously decided against the application of the reclassification option or did not even mention the amendment in their report.[76] The amount of the reclassification of the total sample in 2008 is € 462 billion, and the most widely used reclassifications were from categories HFT to L&R and AFS to L&R. In this manner, banks avoided high reductions in OCI and prevented high losses. However, the authors found that in 2009 already, 70 % fewer banks made use of the reclassification option than in 2008, and in 2010 and 2011 that figure even reached 85 % less compared to 2008.

The most widely used reclassifications were still from AFS to L&R, but within these three years only 28 reclassifications were made. The investigation period, 2009 to 2011, shows a sharp decline in the use of the newly created reclassification option.[77] Regarding the latter, this thesis only considers the use of the reclassification option in 2008. However, the interesting point of this study is the examination of the justifications for reclassification. The phrase ‘rare circumstances’ was hardly used. The authors could find statements of reason such as: intention to hold had changed, financial crisis, lack of liquidity, Greek fiscal crisis, market conditions and other reasons. It is more than dubious that during the height of the Eurozone crisis in 2010-2011, even with the clear statement of the IASB that an economic crisis is an unusual condition, banks most commonly used ‘Intention to hold had changed’ as the reason for reclassification rather than ‘rare circumstances’. This prompts the question to what extent changing the intention to hold is a suitable statement.[78] Therefore, a more detailed analysis of each bank is needed, and this requires higher transparency of the information in the notes of the annual reports.

The underlying idea behind this observation is that banks tried to hide a possible situation of financial distress during the Eurozone crisis and only a few banks had the courage to mention the Greek Fiscal Crisis as a justification to use the reclassification option. From a bank’s point of view it is significant to note that ad-hoc information could harm market efficiency. The information of ad-hoc changes, for instance necessary reclassifications of financial assets due to the sovereign debt crisis, could be anticipated by investors, and this could halt the productiveness of the market. For this reason, the disclosure of the application of the reclassification option has a significant impact on investor behavior. Banks and governmental institutions are right in the sense that too much information in bad times could result in wrong incentives and may lead to a widespread panic. However, proper regulation requires proper transparency and accountability, especially in times of financial distress. The trade-off between financial stability and transparency could be resolved with lessons learned from past occurrences and revised standards for a better prevention in the future.

Accounting of sovereign debt bonds according to IAS 39

The results of the previous study draw close attention to the Eurozone crisis. Now the question arises how government bonds were accounted for according to IAS 39 in the wake of the sovereign debt crisis. The bank bailouts and the global recession in 2009 triggered a European sovereign debt crisis and exposed the reciprocal dependency between sovereigns and banks, above all in the Eurozone.[79] After recognizing that sovereign risk could endanger the stability of the European financial sector, the EU made it clear that a European rescue effort was necessary.

The first country to face financial difficulties at the beginning of 2010 was Greece, resulting in a pan-European intervention executed through a rescue package for Greece. The establishment of the so-called European Financial Stability Facility (EFSF) was set up by the EU and the International Monetary Fund (IMF).[80] According to the European Commission, the creditors of Greece should not suffer a loss in connection with the European intervention. However, the European Council revised this statement in June 2011 and informed the public that in order to reestablish Greek and European financial stability, private creditors needed to suffer a loss.[81] The Eurosummit agreed that a waiver of 50 % would be placed on the nominal amount of the issued Greek government bonds.[82]

This debt waiver for Greece had accounting consequences for those banks that held Greek government bonds in their portfolio. Impairments on financial investments have negative consequences on the stability of the banking sector.[83] To this end the European Securities and Markets Authority (ESMA) underlined that the uniform application of the IFRS would be a key component for the stability and proper functioning of financial markets.[84] In this context, Weber and Pelger (2013) investigated 69 banks from 20 different European countries between 2010 and 2011. The GIIPS (Greece, Ireland, Italy, Portugal and Spain) countries were identified as the most financially distressed countries during the sovereign crisis.[85]

The purpose of the empirical analysis of the authors was to present an overview of the effect of the implementation of the waiver on the balance sheets of European banks. The focus was on the accounting treatment, according to IAS 39, of the government bonds of financially-distressed countries, with special attention given to impairment of Greek government bonds.[86] In the FVTPL category the impairment test is not obligatory; however, on each balance sheet date a reporting company is required to prove those financial assets that are not measured at fair value and consider the allowance for doubtful accounts.[87] In section 2.4 possible reasons for an impairment loss were already mentioned. The analysis of the financial statements indicates that both on 12/31/2010 as well as on 12/31/2011 the majority of GIIPS government bonds in European banks were held in the AFS category. The Greek government bonds that were predominantly assigned in the categories HTM and L&R, and so measured at amortized costs, were an exception.[88] In Appendix 5, the respective distributions of the categories for the financial statements 2010 and 2011 of the GIIPS countries are presented.

In accordance to the impairment requirements of the financial assets in the categories AFS, HTM and L&R considered different initial assessment to determine whether objective evidence of impairment exists. Even the determination of the relevant evaluation measurement in banks’ accounts are varying.[89] These differences can be attributed to discretions of the standard. As long as no impairment arises the differences will be not significant. Until the second quarter of 2011, during which no reasons for impairments on Greek government bonds arose, the standard to IAS 39 seemed to be uniform. Until the announcement that private creditors suffered a loss because of the Euro rescue program in July 2011. In the aftermath banks used this event as objective evidence for an impairment loss on Greek government bonds. The fact is that after the recognition of the impairment loss of Greek government bonds the different procedures were adopted to determine the new balance value.

The disparities in implementation of IAS 39 hamper the comparability of bank balance sheets. Weber and Pelger (2013) noticed, that the recommendations of the ESMA have not been implemented consistently, therefore, there is no unified view of the endangered European government bonds. As a conclusion, the authors found that there are differences between the banks regarding the application of the provisions of the IAS 39.[90] Reducing discretion within the rules and a consistent application, from the perspective of the recipients of their financial statements, is desirable. IFRS 9 will try to harmonize the standard to avoid clumsiness in future.

2.6 Fair Value Hierarchy of Financial Assets

In the literature there is no examination of the impact of the fair value measurement on the reclassification option. It is well-known that the amendment enables reclassification of financial assets previously recognized at fair value into categories that require a measurement at amortized costs or at fair value through OCI. However, before the categorization of these assets the fair value has to be determined for those assets that should be categorized at mark-to-market. Weber and Pelger (2013) mentioned in their study that banks used the Level 3 measurement during the sovereign crisis more often, with the justification that there is no active market for government bonds.[91] This leads to the prediction that during the financial crisis a change in the fair value hierarchy might have been visible, which affected the reclassification option.

On May 12, 2011, the IASB and the FASB issued a new guidance on fair value measurement and disclosure requirements for IFRS and US GAAP. The new guidance is stated in IFRS 13 and specifies the Fair Value Measurement. It includes the designation of fair value, demonstrates a framework in a single IFRS for determining fair value, and indicates disclosures about fair value measurement.[92] IFRS 13 characterizes fair value as the price that would be received to sell an asset or paid to transfer a liability in a precise operation between market participants at the measurement date. Fair value is not an entity-specific measurement, but a market-based measurement.[93] To avoid inconsistency and enhance comparability for third parties in the fair value valuation, the IFRS established a fair value hierarchy that categorizes the inputs to the measurement techniques used to define a proper fair value into three levels. On the fair value hierarchy, the Level 1 inputs, gives the highest priority to quoted prices in active markets for identical assets or liabilities, and the Level 3 inputs, the lowest priority to unobservable inputs. The following table describes each level.[94]

Table 1: Fair Value Hierarchy[95]

illustration not visible in this excerpt

The borderline between the three fair value levels is not always clear, especially when comparing 1 with 2 and comparing 2 with 3.

The following studies show the importance of the fair value hierarchy on the financial market and are therefore important for the predictions of this thesis regarding the relaxation option. Bergheim, Ernstberger, and Roos (2014) examine whether the fair value measurement of financial instruments affects the decision of investors to invest in banks’ shares.[96] So the value of a bank’s assets is partially dependent on the fair value hierarchy. A decisive aspect is the accuracy of fair value estimates and consequently investors’ reaction to the assets of the fair value hierarchy and the impact on net income. The authors consider the interaction between different levels of valuation and fair value adjustments. They find that investments decline as a result of a changeover from the 1st to the 3rd Level. In addition, they state that the valuation of the fair value level solely plays a role on investment in the case of negative adjustments, so downpricing by the market is noted as a negative sign. For Level 2, the results are not straightforward; as a hybrid, it includes elements of Level 1 (market prices) and Level 3 (model assumptions).[97] Banks consider investors’ reaction because an important part of their assets are commonly trading securities, which are priced at fair value.

The authors Clor-Proell et al. (2010) found in their study that nonprofessional investors assign various reliabilities to fair value valuations based on 1st and 3rd Level inputs. In another experiment, Song et al. (2010), document the value relevance of different fair value levels. However, in contrast to Clor-Proell et al. (2010) Song et al. (2010) discovered that fair value valuations of Level 1 and 2 are more relevant than the fair value valuation of Level 3.[98] Furthermore, the authors Allen and Carletti (2008) argue that the relevance of using fair values for decision making depends on the liquidity of the financial market and hence relies on the level of inputs that are used for fair value estimates.[99]

Many researchers have examined the fair value levels and the reclassification option separately, but little is known about the impact of a bank’s fair value measurement on the likelihood of reclassification. The financial crisis marks a time of illiquidity on the market and of declining confidence in the banking sector. If a bank’s fair value assets are dependent on the fair value hierarchy, then it appears that the use of the reclassification option is influenced by this as well. So according to the literature Level 2 and Level 3 do not have a significant impact and the value relevance is controversial. All authors agree that Level 1 is relevant for investments. A possible reason is that Level 1 is completely dependent on the market, while Level 3 is based on a banks’ own calculations and predictions. That is precisely why the willingness of a third party to invest is highest for valuations that are on Level 1 of the fair value hierarchy.[100] The last level leaves room for discretion and, especially in times of confidence loss in the banking sector, the market seems more credible than the bank’s own calculation because it provides transparency and limits the opportunities for managerial influence. Even if the fair value measurement according to the fair value hierarchy is an obligation and not a choice, entities will try to benefit from discretion.

Banks could therefore try to increase the amount of assets in Level 1 in times of financial constraints. They would do this for two reasons: one is that from the investor’s perspective the change from Level 1 to Level 3 could indicate an anticipated value decline, according to the existing studies. Banks could therefore try to avoid possible investment cuts because of opacity. The second reason is that from the company’s view their own calculation on Level 3 is much more costly than the benchmark measurement and they try to avoid additional costs. The prediction is therefore that the fair value levels have a positive influence on the reclassification option, with Level 3 having a bigger effect than the rest. Regarding the reclassification amount, it is also predicted that each level has a positive relationship. However, the amount of reclassification is lower when the amount of assets in Level 1 is higher. The last level of the fair value hierarchy leaves room for discretion. For an investor the market seems more credible than the bank’s own calculation because it provides transparency and limits the opportunities for managerial influence. So the higher the amount on Level 3, the higher the amount of reclassification will be, whereas the opposite is true for Level 1.

3 Data and Statistics

3.1 Data Sources and Sample Selection

The sample relies primarily on the annual reports of each bank and on three commercial databases: Orbis (Bureau van Dijk), Capital IQ and Bloomberg. The initial sample of banks was obtained from Orbis, which is a database that provides company information on companies worldwide.[101] My selection proceeded as follows. The first criterion was that the company has to be classified as a bank, considering that the reclassification option was amended for banks. The second criterion is the SIC code. The following codes are included (primary codes only): 60 - Depository institutions; 61 - Non-depository credit institutions; 62 - Security and commodity brokers, dealers, exchanges and services; 63 - Insurance carriers; 64 - Insurance agents, brokers, and service; 65 - Real estate; 67 - Holding and other investment offices. This confirms that solely financial activities are included.

The third criterion was the geographic region. In the existing literature there are inconsistencies in the results of European and American banks in the same test. One reason for that could be the difference in local capital market regulation (see Bischof et al. (2014) vs. Kholmy and Ernstberger (2010)). Furthermore, the Amendment IAS 39 was especially important for European banks as it harmonized the IFRS with the US GAAP. Therefore my focus here, similarly to Georgescu (2014), Fiechter (2011), and Kholmy and Ernstberger (2010), is on European banks, specifically the Western region of Europe. The final, but important, criterion is that banks have to be classified as IFRS users; otherwise the Amendment to IAS 39 and to IFRS 7 is not applicable. These are banks with the consolidation code C1, C2, and U1.[102]

Consequently, 2258 banks which are located in Western Europe and classified as IFRS users are identified. From the initial sample all banks without an International Securities Identification Number (ISIN) for their equity securities are excluded to have a unique code for the other two databases. After this process, the sample end up with 297 banks from 26 European countries. Besides, the securities are traded in 24 different exchanges and 79 banks from the initial list are delisted or the exchange is not present in Orbis.[103] The remaining sample includes publicly listed banks, non-publicly listed banks, commercial banks, saving banks, cooperative banks, bank holding companies, investment banks, real estate banks, mortgage banks and private banking. The study examines only the use of the reclassification option in 2008. As noted in Section 2.5, the reclassification option was rarely used in subsequent years and they are therefore not considered here. For the sample of 297 banks, the annual reports for 2008 from various sources such as Capital IQ, Bloomberg, company websites, and in a few cases via e-mail to the investor relations department of the company are manually collected. Another 42 banks had to be excluded from the initial sample for different reasons. Table 2 shows the reasons for the exclusion.

Table 2: Reasons for excluding banks[104]

illustration not visible in this excerpt

This procedure yields a final sample of 255 banks from 23 countries.[106]

Finally the information about the reclassification choice and, if given, the total amount of the reclassification of financial assets are manually extracted. The information was obtained from the footnotes of each annual report of 2008. All other relevant data is retrieved from the databases. The reclassification amount represents the fair value amount of the reallocated assets at the reclassification date, not the carrying value at the balance sheet date. Banks that meet the requirements for the reclassification option but do not mention the amendment in the accounting policies are considered as non-reclassifying banks.

The databank S&P Capital IQ is a financial information provider and offers, among other data, company and fund research.[107] Capital IQ provided the data for the Fair Value Hierarchy and the CDS spreads to this thesis. However, data is not available for all 255 banks. The data on CDS spreads is often difficult to assemble and therefore partly incomplete; spreads are only available from very large companies. To get more data from the debt market, in addition to the CDS spreads, the probability of default of the issuer over the next year calculated by the Bloomberg Sovereign Default Risk model is used. This is simply the probability of the company defaulting over the next one year. Bloomberg is a financial software and data company and through the Bloomberg Terminal it offers financial software instruments such as an analytics and equity trading platform, data services, research and news to financial companies and entities.[108] Our debt market condition variables thus include CDS spreads and default probability. The market capitalization is also provided by Bloomberg. The firm characteristics are all extracted from the Orbis databank. Due to the lack of a common currency basis, the exchange rates deposited in Orbis for the year 2008 are used. For foreign exchange (FX) rates used in this study, see Table 28 in Appendix 9. Including the Euro, eight different currencies are considered. For the data analysis, the statistics program Stata is used as well as Microsoft Excel. Stata is an integrated statistical software package that provides extensive resources for data analysis, data management, and graphics.[109]

3.2 Definition of Variables

Table 3 summarizes all variable definitions and sources, which are used in the course of this analysis. The variables were determined on the basis of the balance sheet date of 12/31/2008.

Table 3: Definition of Variables

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In total, 22 variables are used in the scope of this analysis. One of the main variables is the dummy variable Reclas. This has a value of 1 if a bank reclassified through the Amendment to IAS 39 in 2008, and 0 if the bank has not yet taken advantage of this right. The aim is to figure out whether banks reclassified and which indicators could be identified for this reaction. The second main variable is Reclas amount, which represents the fair value amount of the reclassification at the reclassification date if banks took advantage of the reclassification option. The objective is to determine from which firm characteristics or other indicators the amount of reclassification can be derived, if any. The main reasons for choosing reclassification are: avoiding fair value loss in the income statement, and reallocating financial assets from the fair value category at amortized cost to sufficiently fulfill the regulation capital. Moreover, this Amendment was also done to better align IFRS with US GAAP. On the other hand, the reclassification reduces transparency for investors about the current value of the securities. It could be also a signal of financial distress for investors and this could harm the stock price and consequently the market cap. Taking advantage of the reclassification option therefore implies a trade-off.

The choice of the variables Tier 1 capital ratio, CDS 5Y Mid Price, Default probability, Amortization, ROE, and Cash ratio were already discussed in section 2.5 and can be derived from the presented literature. However, in a simplifying assumption the Tier 1 ratio and the capital adequacy ratio (CAR) are used to present the relation between the regulatory capital of a bank and the reclassification choice. Distinctions between prudential filters, Tier 2 capital, and additional capital are not made here. The reason for this is insufficient data and because Tier 1 capital is the base of the regulatory capital and therefore meaningful enough. If a bank does not even reach the necessary 4.5 %, the rest of the regulatory capital is irrelevant. The liquid measurement cash ratio is representative for liquid assets or cash reserves but the prediction is still the same as in section 2.5. If the cash ratio increases, the banks are less likely to reclassify. The reason for using the ratio is that a ratio is more meaningful than the absolute amount of cash reserves and allows an easier comparison with other entities.

The variables Level 1, Level 2 and Level 3 are indicators for each level of the Fair Value hierarchy and were already explained in section 2.6.

I then looked for variables that mirror the performance and the size of the banks. These variables are Market cap, Total assets, Accounting equity, ROA based on profit/loss before tax, Price-earnings ratio, Current liabilities, and Annual surplus/loss. These could also be seen, as in a lot of other studies, as the control variables of a statistical analysis. Control variables are essential to account for the differences in size and performance between the individual objects, but it is not surprising that a connection to the main variable exists.

Finally, the distributed dividends variable is included because of two possible argumentations. One is that banks that distributed a high dividend in 2008 did not use the reclassification choice. Because a high distributed dividend is a positive signal that the company performed well, especially considering that equity holders are paid last, the company must have enough capital to cover all obligatory debt and investment costs and consequently pay a high dividend. It seems then that banks do not need the reclassification of financial assets for any capital.

The other prediction relies on the old pecking order theory that dividends are sticky.[110] Dividend policies and investment opportunities are based on the fact that internally-generated cash flow may be more or less than investment outlays. If it is less, the firm first reduces its cash and cash equivalents or marketable securities portfolio. If it is more, the firm first repay the debts or invests in cash or marketable securities. If the surplus persists, it may successively increase its target payout ratio.[111] And publicly traded companies often set absolute dividends and stick with those dividends through good times and bad. The reason for this behavior is that the stock price is negatively affected by a reduction in distributed dividends. In a few cases some companies have consistently raised dividends and continued to do so even in the worst of times. If banks’ behavior in this sample follows the latter prediction then the reclassification option is positively linked to a high level of dividends. In this case banks would reclassify to satisfy their shareholders.

In addition the dummy variable, disclosure quality, is included. The reason for this is that the Amendment to IAS 39 and IFRS 7 is an ad hoc change from the IASB and should be mentioned at least under the accounting policies in the annual reports, regardless of whether banks make use of the option or not. This variable is used under simplified assumptions here. If a bank fulfills the disclosure requirements according to IFRS 7 and presents the reclassification amount on its financial reports or if it explicitly mentions that it is not using the option, then the bank has a good disclosure quality.

3.3 Sample Characteristics and Representativeness

Of my sample of 255 banks, 36.08 % took advantage of the Amendment to IAS 39 and reallocated assets in the amount of 682,437.23 million euros from the fair value category to the amortized costs category. As shown in Table 4, a total of 92 banks reclassified and 163, about two third of the banks in this sample, chose not to take the opportunity. The range in the reclassification amounts, from € 0.03 million to € 2,676 million shows that the option is used to a strongly varying extent.

Table 4: Statistics on the Use of the Reclassification Option[112]

illustration not visible in this excerpt

Based on my review of each annual report, it should be noticed that there are differences in disclosure qualities. Out of the 163 non-reclassifying banks, 116 banks state that they do not apply the amendment in either IAS 39 or IFRS 7 or that the change does not have a significant impact on the income statement. In total, 82 % (208 out of 255) of the entire sample disclose details on the reclassification choice in full compliance with the IFRS 7 requirements. No indication was given by 47 banks of 163 non-reclassifying banks (28.8 %; see Figure 1) about the opportunity to reclassify. So regarding the sample of 255 observations, 18 % did not provide sufficient information and are therefore identified as banks with low disclosure quality.[113] The top 3 countries of these 47 banks are: Great Britain with 10 banks (out of 35), Italy with 5 banks (out of 22), followed by Turkey with 4 (out of 9) banks.

illustration not visible in this excerpt

Figure 1: Use of the Reclassification Option in 2008[114]

For a more detailed analysis of the presented data set, Table 4 in Appendix 11 shows the descriptive statistics of the total sample. Despite the evaluation of one balance sheet day, it is difficult to make statements about before and after the reclassification date and point out the development of specific accounts. However, by dividing the banks into two groups, reclassifying banks and non-reclassifying banks, one can draw conclusions about the consequences on the financial statements from the appropriate variables at the end of the year in 2008. In Tables 29 and 30 in Appendix 12 the descriptive statistics for (a) reclassifying banks and (b) non-reclassifying banks are shown. The data should be interpreted carefully, as it is not all based on an equal number of observations. The databases do not possess every single bit of information on each of the 255 banks.

Nonetheless, a comparison of (a) and (b) shows the following tendencies. Looking at the mean of the total assets, (a) € 325 billion and (b) € 41,234 million, it appears that large banks made more use of the relaxation option than smaller banks. Comparing the medians of the two samples reveals a huge difference of € 59.152 million. Even if sample (a) consists of 75 banks and sample (b) of 133 banks, the smallest amount of total assets in (b) is ten times smaller than the smallest amount of total assets in (a).

Similar differences in the samples also apply to the total equity amount. As expected, the market cap, which represents the current market value of the firm and also serves as a size variable, shows that non-reclassifying banks have a higher market value. Banco Bilbao Vizcaya Argentaria SA from Spain, which did not use the option, has the highest market cap at the end of 2008 in the sample, with € 32,173 million. The maximum market cap in the reclassifying group is € 31,750 million, for the bank Intesa Sanpaolo from Italy.


[1] See IFRS (2001).

[2] See Ramanna/Sletten (2009), p. 4.

[3] See IASB (2008).

[4] See Hughes/Tett (2008), p. 1.

[5] See IASB (2008).

[6] See Laux/Leuz (2009), p. 826.

[7] See Bischof/Brüggemann/Daske (2014), p. 1.

[8] See Ball (2008), p. 2.

[9] Ball (2008), p. 4.

[10] See Kuhn/Scharpf (2006), p. 4-5.

[11] See Kuhn/Hachmeister (2015), Teil B, Tz. 3.

[12] See Kuhn/Scharpf (2006), p. 101.

[13] See Kuhn/Scharpf (2006), p. 102-103.

[14] See Kuhn/Scharpf (2006), p. 122-123.

[15] See Kuhn/Scharpf (2006), p. 124.

[16] See Wagenhofer (2009), p. 248-249.

[17] See Appendix 1: Overview of the Recognition and Measurement according to IAS 39 for Financial Assets.

[18] See Wagenhofer (2009), p. 250.

[19] See Kuhn/Hachmeister (2015), Teil B, Tz. 128.

[20] See Kuhn/Hachmeister (2015), Teil C, Tz. 385.

[21] See IASB (2008), p. 1.

[22] See IASB (2008), p. 2.

[23] See Bischof/Brüggemann/Daske (2014), p. 5.

[24] See IIF (2008), p. 14.

[25] See IASB (2008), p. 3.

[26] See IASB (2008), p. 1.

[27] See Georgescu (2014), p. 7.

[28] If no impairment is activated fair value gains and losses can be dropped to be recognized as profit or loss.

[29] See Bischof/Brüggemann/Daske (2014), p. 6.

[30] See Georgescu (2014), p. 7.

[31] See IASB (2008), p. 1.

[32] See CESR (2009), p. 2.

[33] See Retzel/Daniel (2010), p. 18.

[34] See Barth/Caprio/Levine (2013), p. 2.

[35] See Balthazar (2006), p. 1.

[36] See Hull (2010), p. 221.

[37] See Hull (2010), p. 222.

[38] See Terzi/Ulucay (2011), p. 988.

[39] See BIS (2011), p. 59.

[40] See BIS (2011), p. 12.

[41] See Bischof/Brüggemann/Daske (2014), p. 8.

[42] See Bischof/Brüggemann/Daske (2014), p. 9.

[43] See Bischof/Brüggemann/Daske (2014), p. 10.

[44] See CEBS (2007), p. 7.

[45] Early in 2004 the CEBS published corresponding rules for adjustments to be made to the equity reported in consolidated financial statements prepared according to IFRS.

[46] See CEBS (2007), p. 7.

[47] See German Banking Industry Committee (2013), p. 14.

[48] See Bischof/Brüggemann/Daske (2014), p. 11.

[49] See Bischof/Brüggemann/Daske (2014), p. 10.

[50] See Hull (2010), p. 32.

[51] See Ismailescu/Kazemi (2010), p. 2862.

[52] See Fiechter (2011), p. 49.

[53] See Fiechter (2011), p. 50.

[54] See Bischof/Brüggemann/Daske (2014), p. 7.

[55] See Kuhn/Hachmeister (2015), Teil C, Tz. 11.

[56] See Weber/Pelger (2013), p. 344.

[57] See Bischof/Brüggemann/Daske (2014), p. 7.

[58] See Fiechter (2011), p. 52.

[59] See Bischof/Brüggemann/Daske (2014), p. 15.

[60] See Laux/Leuz (2009), p. 826.

[61] See Bischof/Brüggemann/Daske (2014), p. 9.

[62] See Bischof/Brüggemann/Daske (2014), p. 39.

[63] See Bischof/Brüggemann/Daske (2014), p. 42.

[64] See Georgescu (2014), p. 4.

[65] See Appendix 4 for the definition of CDS.

[66] See Gorgescu (2014), p. 11.

[67] See Gorgescu (2014), p. 33.

[68] See Gorgescu (2014), p. 11.

[69] See Gorgescu (2014), p. 18.

[70] See Gorgescu (2014), p. 33.

[71] See Gorgescu (2014), p. 11.

[72] See Guo/Matovu (2009), p. 1.

[73] See Guo/Matovu (2009), p. 2.

[74] See Bowen/Khan/Urooj (2014), p. 235.

[75] See Bowen/Khan/Urooj (2014), p. 256.

[76] See Jarolim/Oeppinger (2013), p. 351.

[77] See Jarolim/Oeppinger (2013), p. 353-354.

[78] See Jarolim/Oeppinger (2013), p. 355.

[79] See Arnold (2012), p. 906.

[80] See Weber/Pelger (2013), p. 343.

[81] See Europäischer Rat (2011b), Tagung p. 5.

[82] See ESMA (2012), p. 6.

[83] See Weber/Pelger (2013), p. 343.

[84] See ESMA (2011), p. 1.

[85] See Weber/Pelger (2013), p. 345.

[86] See Weber/Pelger (2013), p. 343-344.

[87] See Weber/Pelger (2013), p. 343.

[88] See Weber/Pelger (2013), p. 346.

[89] See Weber/Pelger (2013), p. 349.

[90] See Weber/Pelger (2013), p. 350.

[91] See Weber/Pelger (2013), p. 350.

[92] “A company has to disclose information that helps users of its financial statements assess both of the following: a) for assets and liabilities that are measured at fair value on a recurring or non-recurring basis in the statement of financial position after initial recognition, the valuation techniques and inputs used to develop those measurements; b) for recurring fair value measurements using significant unobservable inputs (Level 3), the effect of the measurements on profit or loss or other comprehensive income for the period”; see IFRS 13 (2013).

[93] See IFRS 13 (2013).

[94] See IFRS 13 (2013).

[95] Source: Own compilation based on IFRS 13 (2013).

[96] See Bergheim/Ernstberger/Roos (2014), p. 3.

[97] See Bergheim/Ernstberger/Roos (2014), p. 25-26.

[98] See Clor-Proell/Proell/Warfield (2010), p. 6.

[99] See Allen/Carletti (2008), p. 360.

[100] See Bergheim/Ernstberger/Roos (2014), p. 6.

[101] See Bureau van Dijk (2015).

[102] See Appendix 6 for the search strategy in Orbis.

[103] See Appendix 7 for the appropriate country lists.

[104] Source: own research.

[105] See Appendix 8 for final sample.

[106] See Appendix 7 for the appropriate country lists.

[107] See Capital IQ (2015).

[108] See Bloomberg (2015).

[109] See Stata (2015).

[110] See Myers (1984), p. 581.

[111] See Myers (1984), p. 582.

[112] Source: own research.

[113] See Appendix 10 for the list of banks with low disclosure quality.

[114] Source: own research.

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Economic Consequences of Fair Value Reclassifications of Financial Assets According to IAS 39
An Emprical Analysis
University of Hohenheim
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IAS 39, Financial Instruments, Reclassification Option, Financial Crisis, Empirical Analysis
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Meryem Önüt (Author), 2015, Economic Consequences of Fair Value Reclassifications of Financial Assets According to IAS 39, Munich, GRIN Verlag,


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