Risks and challenges of complex financial isntruments: an analysis of SSM banks

Rosario Roca (rosario.roca@bancaditalia.it), Francesco Potente (francesco.potente@bancaditalia.it), Luca Giulio Ciavoliello (lucagiulio.ciavoliello@bancaditalia.it), Alessandro Conciarelli (alessandro.conciarelli@bancaditalia.it), Giovanni Diprizio (giovanni.diprizio@bancaditalia.it), Lanfranco Lodi (lanfranco.lodi@bancaditalia.it), Roberto Mosca (roberto.mosca@bancaditalia.it), Tommaso Perez (tommaso.perez@bancaditalia.it), Jacopo Raponi (jacopo.raponi@bancaditalia.it), Emiliano Sabatini (emiliano.sabatini@bancaditalia.it) and Antonio Schifino (antonio.schifino@bancaditalia.it)
Additional contact information
Rosario Roca: Bank of Italy
Francesco Potente: Bank of Italy
Luca Giulio Ciavoliello: Bank of Italy
Alessandro Conciarelli: Bank of Italy
Giovanni Diprizio: Bank of Italy
Lanfranco Lodi: Bank of Italy
Roberto Mosca: Bank of Italy
Tommaso Perez: Bank of Italy
Jacopo Raponi: Bank of Italy
Emiliano Sabatini: Bank of Italy
Antonio Schifino: Bank of Italy

No 417, Questioni di Economia e Finanza (Occasional Papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: We investigate the valuation risk affecting financial instruments classified as L2 and L3 for accounting purposes. These are instruments that are not directly traded in active markets and are often relatively complex, opaque and illiquid. There is a huge volume of L2 and L3 instruments in the balance sheets of SSM banks (around �6.8 trillion worth, considering both assets and liabilities). We argue that the complexity and opacity of these instruments create substantial room for discretionary accounting and prudential choices by financial intermediaries, which have incentives to use this discretion to their advantage. The current regulatory reporting standard is not sufficient to make a comprehensive assessment of the overall risks stemming from L2 and L3 instruments. We highlight that these instruments share some characteristics with NPLs (illiquidity, opacity), and argue that the risk they pose might also be comparable.

Keywords: fair value accounting; level 2 instruments; L3 instruments; prudential regulation (search for similar items in EconPapers)
JEL-codes: G21 G28 G32 M41 (search for similar items in EconPapers)
Date: 2017-12
New Economics Papers: this item is included in nep-acc, nep-cba, nep-cfn and nep-hme
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:bdi:opques:qef_417_17

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