The chairman of the Federal Deposit Insurance Corporation (FDIC) wants to put a warning label on banks. Thomas Hoenig wants to label the four largest US lenders as being much bigger than they appear.
If derivatives and off-balance-sheet assets were held to much stricter accounting standards, banks would emerge twice as big as they are now. They would be almost as large as the entire US economy.
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Derivatives are like loans; they carry risk. Stricter accounting for them would reveal a better picture of the risk levels as they actually are.
US accounting standards allow banks to account for a smaller portion of their derivatives exposure than their European counterparts.
This means they can keep most of their mortgage-linked bonds off their books. This can cause them to underestimate inherent risks as well as how much capital they need for loan-loss reserves.
Applying international accounting standards for derivatives and consolidating mortgage securitizations would double the size of JPMorgan Chase & Co., Bank of America Corp., and Wells Fargo & Co.
Citigroup’s assets would increase by 60%. Off-balance-sheet assets and derivatives were the foundational elements of the 2008 credit crisis.
US accounting standards allow banks to net out the trading positions they have with each other to see what would be owed if all contracts had to be settled on point.
When a bank’s solvency is in question, derivatives partners demand to be paid immediately. This can cause a run.
The accounting differences in the US and international standards lay at the heart of the debate in Basel.