![]() ![]() Proponents argue that MVA would reveal the closest approximation to the true economic value of a bank-its capital-and that it would help both shareholders and regulators better monitor a bank's financial condition. The use of MVA has been hotly debated for several decades. Full market value accounting would require all assets and liabilities to be valued in a similar fashion. For an asset that is actively traded, like a government bond, the market price is the best estimation of the asset's true economic value. Market values, then, are based on expected cash flows and foregone investment opportunities. This type of risk is called credit or default risk. Of course, the market value of that instrument would also decline if the borrower paid back only half the principal: The banker loses the opportunity to invest and earn interest on the remaining $500 outstanding in addition to the loss of principal. The possibility that changes in market rates will cause changes in earnings or the value of portfolios of assets and liabilities (and hence capital) is called interest rate risk. In contrast, by HCA, this asset would be valued at $1,000. 2 The market value of the instrument would fall because a buyer would need to be compensated for the difference between the interest rate on that instrument (10 percent) and the going market interest rate (12 percent). ![]() This rise in interest rates would reduce the price (or market value) at which the bank could sell the loan or security at mid-year. Suppose midway through the year, market interest rates rise to 12 percent. Suppose a banker purchases a one-year fixed-rate security (or makes a lump-sum, one-year loan) with an interest rate of 10 percent, the current market interest rate. 1Ī simple example will illustrate the point. With HCA, assets and liabilities are reported at their contractual values, which may or may not equal their market values. Historical cost accounting (HCA) is the accounting method traditionally used by most financial institutions. ![]() Much of the S&L losses ultimately borne by taxpayers could have been averted, MVA proponents say, if bank accounting methods had reflected the current rather than historical value of assets and liabilities. The call for MVA has gained momentum in recent years, in part because of the savings and loan (S&L) crisis, during which traditional bank accounting methods failed to reveal the huge unrealized losses imbedded in S&Ls' mortgage portfolios. MVA, also known as fair value accounting or marking to market, requires that an asset or liability be valued according to its market price, that is, the current price at which it could be sold. These new standards fall under the general category of market value accounting (MVA). Within the last two years the Financial Accounting Standards Board, or FASB (pronounced FAZZBEE), the chief rule-making body for accountants, has approved several proposals that alter the way banks and other financial institutions make financial disclosures. Now the accountants are getting in on the act. bankers have been struggling lately to keep up with increased regulatory and congressional scrutiny of their activities. ![]()
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