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© 2009 International Monetary Fund


IMF Working Paper
Research Department
Accounting discretion of banks during a financial crisis
Prepared by Harry Huizinga and Luc Laeven1
Authorized for distribution by Stijn Claessens
September 2009
This Working Paper should not be reported as representing the views of the IMF.
The views expressed in this Working Paper are those of the author(s) and do not necessarily represent
those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are
published to elicit comments and to further debate.

This paper shows that banks use accounting discretion to overstate the value of distressed assets.
Banks’ balance sheets overvalue real estate-related assets compared to the market value of these
assets, especially during the U.S. mortgage crisis. Share prices of banks with large exposure to
mortgage-backed securities also react favorably to recent changes in accounting rules that relax
fair-value accounting, and these banks provision less for bad loans. Furthermore, distressed
banks use discretion in the classification of mortgage-backed securities to inflate their books.
Our results indicate that banks’ balance sheets offer a distorted view of the financial health of
the banks.
JEL Classification Numbers: A10; A11
Keywords: Key bank regulation, accounting standards, fair value accounting, corporate
disclosure, financial crisis
Author’s E-Mail Address:;

Huizinga is Professor of Economics at Center, Tilburg University, and Research Fellow at CEPR; Laeven is
Senior Economist at the International Monetary Fund, and Research Fellow at CEPR. We would like to thank
Rocco Huang, Christian Leuz, Joe Mason, Lev Ratnovski, and Wolf Wagner for comments or suggestions, and
Mattia Landoni for excellent research assistance. The findings, interpretations, and conclusions expressed in this
paper are entirely those of the authors. They should not be attributed to the IMF. Contact information: Harry
Huizinga:; Luc Laeven: