Fair Value Accounting and Procyclical Behavior in the Swedish Banking Sector

Abstract

Introduction The recent financial crisis has given rise to a discussion among academics and the general public on how accounting contributed to the calamity. Fair value accounting has been called into question as being procyclical. It is discussed weather this could also be said of the Swedish financial sector which is somewhat dissimilar from the American. Theory While many in the research community claims that accounting is a neutral measurement system, some researcher claims that accounting also affects what is being measured, i.e. corporations. Fair value accounting in particular could influence market participants because of its fluent nature. Not least has it been shown that U.S. investment banks act upon fair value changes in their capital bases by increasing leverage, thereby causing a procyclical effect in the economy. The Swedish banking system is however not constructed in the same way as the U.S. leaving room for a study of a similar behavior in Sweden. Methodological This study uses a positivistic approach, with a quantitative research discussion design. Secondary data on percentage change in Leverage and Total assets for the big four Swedish banks for the period Q1 2001 to Q4 2010 were plotted and a linear regression was made. Also data on how much Fair value assets contribute to earnings for the banks were collected. Empirical The plots show a distinct positive pattern, even though scattering is findings rather profound. Data points in the quadrants indicating positive relationship between Leverage and Total assets changes outnumber the opposite quadrants by almost 3 to 1. It is shown that Fair Value assets represent a sizeable share of the income of the Swedish banking sector. Analysis A linear regression was made of the scatterplot containing data from all banks, it showed a positive relationship. The statistical data had a high degree of certainty but a rather low degree of explanatory power, meaning that several other important factors contributed to the banks choice of leverage. An attempt to raise the explanatory power was made through omitting the four quarters when bank had made rights issues. This successfully raised explanatory power somewhat, but still other factors outside of the model exist. Conclusions The Swedish banks do actively manage their balance sheets in response to changes in Leverage. They do not target a specific Leverage ratio but increase leverage when Total assets rise, thereby contributing in a procyclical manner to the economy. Omitting four quarters which were ones when banks had made rights issues and thereby distorted the measurement increased explanatory power of the linear relationship slightly.