The longer I work in banking, the more I believe that the best title I ever wrote for an article was “Should Bank Annual Reports Be in the Fiction Section of the Library?”

There are countless examples of banks adjusting numbers to achieve management’s goals. For example, a bank might sell an asset or make some other one-time decision every year to help its bottom line look better. All too often this works, because so many investors react to the published numbers without digging into them.

Also, two banks might swap checks just before statement day so each has a new deposit, even though the asset behind each is nothing but float.

These above cases are largely cosmetic or, in the case of asset sales, easily recognized and accounted for. But some internal accounting options can produce artificial or hyped numbers that can do real damage to the organization.

Many of these involve the misuse of performance incentive programs. These programs can be a real motivator when properly utilized. Sometimes they lead to genuine ingenuity in building the bank.

A good example is a cash reward for getting customers to build up their accounts. Naturally, tellers and other contact officers should be the beneficiaries here. But a bookkeeper at one bank that had such a program enclosed a personal note in each statement she sent out. In the note, she asked the customers to add some money to their accounts and give her the credit for suggesting it. Many did.

Incentive programs that reward tellers for cross-selling also can be of value, though many banks fear that the tellers will take so much time trying to sell to the customers at their stations that the line in the lobby will get out of control.

But incentive programs for lending officers can lead to a hyped balance-sheet performance that is far more dangerous to the bank. Lenders can be tempted to base their decisions on how the loan makes the statement look now, rather than whether the borrower will eventually pay back the loan.

That is why some bankers feel that any incentive for lending officers should be paid out only when the loan has been repaid.

In the same vein, I remember one serious case in which an investment officer sold his bank’s bonds that had coupons above market levels, paid the taxes on the sale, and reinvested the proceeds in lower-yielding bonds. The bank’s immediate profits soared, but the potential for future profits was, of course, damaged.

Why did he do it? He was in a profit-sharing program, so he collected a portion of the bank’s earnings from the sale. Since he obviously did not care what happened to the bank in the future, the sale was a sound decision for him, but a poor one for the bank.

Whose fault is was it? The investment officer’s of course, but also the bank’s, for setting up a disincentive to sound long-term policy.

Banks can make a similar mistake when they do not realize losses on bonds because they do not want to report losses. There are substantial tax savings in taking such losses; those savings plus the proceeds of the sale can be invested in higher-coupon securities.

Finally, some banks simply refuse to report losses on loans, because they fear that the bad news will hurt their stock price.

Banking is a complex game. There are many opportunities to make subjective accounting and reporting decisions that can hurt long-term viability. Analysts ignore this at their own peril.

Mr. Nadler, an American Banker contributing editor, is a professor of finance at Rutgers University Graduate School of Management in Newark, N.J.

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