Rethinking Loan Fair Value Disclosures

Paper: "The Decision Relevance of Loan Fair Values for Depositors"

Journal: Journal of Accounting Research

Published: July 2024

By Rose Semenov

Is the information in banking disclosures relevant? New Carlson School research suggests loan fair values play an important role in depositors’ banking decisions, although the metric may not be a good indicator of loan quality. 

Banks are required to provide disclosures in financial reports about their asset fair values (that is, estimated market values) which can inform depositors’ decision-making. For the disclosures, accounting rules require banks to use estimates of exit prices to report fair values. Advocates say this approach gives depositors a forward-looking view of loan credit quality, allowing them to assess banks’ default risk better. However, critics argue this may be an imprecise method because some factors unrelated to loan credit quality—such as liquidity discount or market interest rates—can cause the loan fair values to decrease. These declines might shake depositors’ confidence and lead to panic-driven withdrawals.

Accounting Assistant Professor Shuyan Wang and her co-authors decided to examine this dividing issue by reviewing data from U.S. commercial banks from 1994 to 2019. They found uninsured depositors are more likely to withdraw their money when their bank loan fair values decrease, even though the overall quality of the bank loans may be in good standing. This depositor response is consistent with declines in fair values informing depositors about depressed loan liquidation values, which generate deposit withdrawals motivated by depositors’ expectations of withdrawals by other depositors.

“Depositors’ response reflects a sense of panic,” says Wang. “This finding is important because it indicates that loan fair value disclosure required by regulators—if it reflects declining liquidation values unrelated to loan quality—may lead to panic runs. But those banks could have been well-operated had the deposits been there and supported them.” 

Wang says the Silicon Valley Bank failure in 2023 drew parallels with the paper’s findings. 

“The primary reason Silicon Valley Bank’s long-term securities values declined was because interest rates rose,” she explains. “Depositors becoming aware of the declining securities values suddenly went to the bank to withdraw their money, forcing SVB to sell their securities at huge losses.” 

Wang says the paper adds fuel to the ongoing debate about fair value disclosures. 

“Our findings could help policymakers evaluate some of the disclosure requirements,” says Wang. “For example, are fair value disclosures precise enough to inform depositors of bank asset quality, or could they adversely impact bank stability?”