Fair Value Reclassifications of Financial Assets During the Financial Crisis

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Abstract
EU politicians pressured the IASB to change the accounting rules for financial assets at the peak of the financial crisis in October 2008. The new rules enabled banks to forgo the recognition of unrealized fair value losses through reclassifications. This paper examines to what extent accounting reclassifications provided banks with regulatory relief and assesses the informational costs of the measure. We find that the impact of reclassifications on regulatory capital is similar to other discretionary accounting choices (e.g., recognition of deferred tax assets), but substantially smaller in magnitude than the impact of real measures (e.g., capital injections). Consistent with a trade-off between regulatory benefits and informational costs, we observe a negative market reaction to banks’ reclassification announcements that is muted if the reclassification helps a bank avoid regulatory capital reductions. Additional analyses of bid-ask spreads during the financial crisis suggest that fair value reclassifications mitigate financial statement transparency as perceived by capital market participants and shed further light on the trade-off behind the accounting choice.