Whether you are for or against full mark-to-market accounting for community banks, I think you’ll agree that it will have a big impact. In the bank lobby’s tug-of-war with FASB you might say it’s a good thing when a regulator chimes-in in-favor of the banks’ position. One Fed Governor has done just that:
Fed Seconds Fair-Value Plan Critique
American Banker, Tuesday, September 15, 2009 (subscription required)
WASHINGTON — Federal Reserve Board Gov. Elizabeth Duke sharply criticized key aspects of a pending accounting proposal that would expose a bank's assets and liabilities — including loans held to maturity and deposits — to fair-value treatment.
In a rebuke Monday to the Financial Accounting Standards Board, Duke echoed industry complaints that the approach fails to recognize how banks conduct operations and could cut off credit to small businesses.
Here is one of the main points made by Duke (as quoted in the article):
Duke appeared more concerned about financial institutions' ability to comply with the rule — "We have very little actual experience in fair-valuing liabilities," she said — and its impact on small banks…"Smaller banking companies likely will incur substantial costs and experience great difficulty in applying the new standards," Duke said. "But will financial statement users see any real benefit?"
While I applaud her observations, I think the point about “very little actual experience in fair-valuing liabilities” can’t emphasized enough.
I don’t think the financial world-at-large truly understands the magnitude of the problem – especially when it comes to valuing non-maturity deposits. A fundamental piece of any fair value analysis is the timing of the future cash flows. What timing are you going to use for checking, savings, and money market accounts? Those of us who make a living modeling interest rate risk know that there isn’t an easy straight-forward answer to this question and, so far, there surely is no standard we can all agree on.
To give you an idea of how big this issue is – a typical bank funds 30% to 50% of their assets with non-maturity deposits. That’s a pretty big chuck of the balance sheet to be marking-to-market using level 3 inputs.