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Financial Stability Paper 31: Understanding the fair value of banks’ loans

Samuel Knott, Peter Richardson, Katie Rismanchi and Kallol Sen
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Samuel Knott: Bank of England, Postal: Publications Group Bank of England Threadneedle Street London EC2R 8AH
Katie Rismanchi: Bank of England, Postal: Publications Group Bank of England Threadneedle Street London EC2R 8AH
Kallol Sen: Bank of England, Postal: Publications Group Bank of England Threadneedle Street London EC2R 8AH

No 31, Bank of England Financial Stability Papers from Bank of England

Abstract: ​Loans are typically the largest asset class on banks’ balance sheets. So understanding the value of loans is vital to any assessment of the resilience of the banking system. This is not straightforward. The market value of loans is seldom observable. And the nature and diversity of banks’ loans has changed markedly over time: the maturity of loans has increased, on average; banks’ mortgage lending has ballooned; and banks use more hard information in their lending decisions. So it is unlikely that any one valuation technique will capture all relevant aspects of valuation across all types of loans. Recognising this, banks are required by accounting standards to disclose the fair value of their loans in the notes to their accounts. At the end of 2013, the fair value of the major UK banks’ loans was £55 billion less than the amortised cost value. This paper explains loan fair value techniques and compares these to other valuation approaches. Fair value approaches include elements of valuation that are not captured by amortised cost approaches, such as lifetime expected credit losses and embedded interest rate gains and losses. As such, fair value disclosures might provide additional insight into the value of some assets, such as longer-term, fixed-rate loans, like mortgages. But loan fair values, like all loan valuation approaches, come with a number of health warnings. For example, they may capture factors that do not necessarily have a bearing on banks’ resilience. As a result, a loan fair value number on its own is often insufficient, which suggests that there may be benefits to improved supplementary disclosures about the drivers of the fair value of banks’ loans to complement balance sheet values.

Keywords: bank regulation; fair value (search for similar items in EconPapers)
JEL-codes: G28 (search for similar items in EconPapers)
Pages: 18 pages
Date: 2014-11-28
New Economics Papers: this item is included in nep-acc and nep-ban
Note: http://www.bankofengland.co.uk/financialstability/Pages/fpc/fspapers/fs_paper31.aspx
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