This study investigates whether fair value accounting contributes to the procyclicality of bank lending. Using banks' approval/denial decisions on residential mortgage applications to capture banks' supply of credit, I find no evidence that fair value accounting has procyclical effects on bank lending over the past two business cycles. I further identify two reasons for this result. First, the main accounting item distinguishing fair value accounting from historical cost accounting-unrealized gains and losses on available-for-sale securities-does not affect lending decisions. Second, unrealized gains and losses on available-for-sale securities are not procyclical, as the risk-free interest rate rises during some expansionary periods, resulting in unrealized losses, while the risk-free interest rate (and sometimes the default spread) falls during some recessionary periods, resulting in unrealized gains.
All Science Journal Classification (ASJC) codes
- Economics and Econometrics