Abstract
M.Com.
The adoption and the application of fair value accounting (FVA) by financial institutions came under severe attack during the financial crisis. Critics of fair value accounting claimed that measuring financial instruments using fair values may have had unintended consequences such as increasing economic shocks, increasing income pro-cyclicality and undermining public confidence. They also indicated that fair value accounting of bank assets/liabilities results in increases in bank lending appetite which exposes financial institutions to credit risk.
This debate presents a major challenge for FVA going forward. In this article, the researcher explores the relationship between fair value accounting of bank assets and bank lending in South Africa, and in particular, whether or not FVA exacerbates the cyclicality of bank lending in South Africa. In order to obtain an understanding of the research objective, the researcher has sought answers to the following questions:
i. Do unrealised gains and losses from FVA affect bank lending?
ii. Is there is a relationship between the FVA of banks’ assets and bank lending behaviour?
iii. Is the FVA of bank assets pro-cyclical?
To address these questions, the researcher have used econometric models, namely, unit root testing, ordinary least squares model, the GARCH-M model, the Johansen co-integration test and Granger causality test. This testing was further explored by means of a trend analysis.
The research was limited to two financial institutions, namely, Bank 1 and Bank 2, using data extracted from the banks’ financial statements from 2003 to 2014. Lending data, asset amounts and fair value movements were used in this assessment.
From the analysis of the results, using GARCH model we have noted that the volatility of FVA in the previous period affects bank lending in the current period. Further to that we noted that these co-efficients from the GARCH model were quite small, meaning that even while there is a positive relationship between...