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This book discusses how FVA affects financial reporting during the 2008 Financial Crisis.



1. Financial Crisis and Fair Value Accounting (FVA)

The global financial crisis (GFC) has drawn attention to the role of financial reporting and to the implications for accounting in times of financial downturn. Many critics attribute blame to the fair value measurement approach, especially for reporting financial instruments in the balance sheets of financial institutions. The focus of the intense debate on fair value accounting (FVA) is whether it is or is not the cause of the financial crisis and whether its pro-cyclical effects towards the economy have played an active role in the financial crisis. The application of FVA would have caused a pro-cyclical consequence on firm’s balance sheet and on profitability, intensifying downturns and decreasing financial stability during the financial crisis.
Elisa Menicucci

2. Fair Value Accounting (FVA): An Overview of Key Issues

Most of the debates of accounting studies focus on the differences between two alternative accounting methods: the approach based on fair value (FVA) and the model based on historical cost (HCA). Both FVA and HCA are in wide use and have their supporters and critics. Proponents of FVA assert it delivers more timely and relevant market information despite the improved use of estimates and judgments, while opponents argue it provides unreliable market information that can misinform investors. Anyway, FVA is considered a good accounting model to assure more reliable financial information, but the reliability of the FVA measurement depends on the availableness of an active market. When markets are severely illiquid, as they are during a credit crunch, FVA implies significant practical difficulties for preparers of financial statements.
Elisa Menicucci

3. The Role of Fair Value Accounting (FVA) in the Financial Crisis

FVA has been criticized for its role in the GFC. During the crisis, the events have proved that while markets are illiquid, financial statements can portray a state that does not reflect the intrinsic economic and financial fundamentals of a company due to FVA. In particular, the financial crisis has shed light on the consequences of fair value measurement in distressed markets and specifically on two key aspects regarding the concept of fair value: volatility and pro-cyclicality. The first strong opposition to fair value is that market values for assets and liabilities risk encouraging too much volatility in the markets under FVA. The second severe criticism is that it can persuade a pro-cyclical stress in asset prices.
Elisa Menicucci

4. Fair Value Accounting (FVA) in the Banking Sector

This chapter analyses the implications of FVA in the banking sector and in particular their impact on banks’ balance sheets and financial stability. A topic of debate, concerning the impact of fair value on financial institutions, is the potential effect of fair value on the volatility of reported earnings and the relationship between pro-cyclicality and FVA. The evidence is that an extensive application of fair values could excessively increase the volatility of banks’ balance sheets and might reduce banks’ capability to respond to distressed economic conditions. We can also appreciate how FVA affects bank regulatory capital and how the use of FVA implies that any liquidity or financial distress at large directly impacts on the level of prudential requirements for equity capital in the banking sector.
Elisa Menicucci


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