A recent Financial Accounting Standards Board proposal would require banks to value assets on their balance sheets, including loans, using a fair-value approach. If enacted, the rule would reduce the amount of capital on banks' balance sheets, particularly during the downward part of the cycle when they most need capital to continue lending. It would hurt banks' ability to lend and, of course, prove harmful to businesses seeking funding. Impaired credit markets and fuzzy financial statements would result. Here's why the proposal should be reconsidered:
• If loans were marked to potentially volatile market prices, banks would be less likely to accept the risk of longer-term loans. Loans held for collection or payment of contractual cash flows differ from short-term assets. Current market prices are not meaningful in assessing their value. It's hard to imagine how marking these assets to market would simplify and improve financial reporting.
• Institutions would recognize changes in fair value under "other comprehensive income" on the balance sheet, incurring huge swings in the book values of assets, particularly for large institutions. This type of volatility is not conducive to a well-functioning global capital market. Downward swings in loan demand would mean lower values for assets and, of course, reduced capital ratios.
• A stated goal of the FASB is to reduce inconsistencies in the reporting of financial instruments. Yet assumptions that establish the fair value of assets, especially those with no ready market, are neither precise nor interpreted and applied consistently. Fair-value assumptions for loans can vary from institution to institution.
• Banks would be required to accelerate recognition of credit losses and periodically calculate the value of core deposits. This would call for tedious software changes and significant additional costs.
• The new rule would exacerbate downturns. Just last year the industry asked the standards board to loosen its fair-value rules because they worsened the effects of the financial crisis. Because there was no market for assets, their market value was zero. Inevitably, this played havoc with capital ratios and clogged credit pipelines.
The rulemakers must understand that mark-to-market accounting will not achieve their goal of greater transparency. On the contrary, it will result in imprecise measurements at best and an impaired credit market at worst.
I encourage everyone to respond to the FASB proposal before the Sept. 30 deadline.