To the extent that asset prices are over-inflated, so too are the recorded profits of the banks. During the downswing, fair value principles are rolled back. Potential losses are then hidden from view. Today, some of the uncertainty around global bank valuations stems from the difficulty in gauging these losses, obscured by provisioning practices in banking books. Regulators and investors alike fear the fog created by such forbearance. In sum, accounting rules in general, and fair value principles in particular, appear to have played a role in both over-egging the financial upswing and elongating the financial downswing. They have tended to over-emphasise return in the boom and under-emphasise risk in the bust. That is not a prudent approach. Indeed, it is a pro-cyclical one. We need accounting rules for banks which are crisis-neutral, valuation conventions for all seasons. What accounting regime might best deliver this robustness? A reasonable starting point would be to recognise the clear differences between bank and non-bank balance sheets, in  3  2  Bernanke and Lown (1991). BIS central bankers’ speeches  particular valuation uncertainty associated with assets and maturity mismatch associated with liabilities. Bank assets and valuation uncertainty Banks’ asset portfolios are not just larger and more complex than for non-financial companies. The business of banking is predicated on banks’ capacity to screen and monitor these assets more accurately than capital markets. Banks serve as a “delegated monitor” for investors.4 This means the risks and uncertainties around the valuation of bank assets are fundamentally different than for non-financial firms.

A distinct accounting regime for banks would be a radical departure from the past.10 But if we are to restore investor faith in banking sector balance sheets, nothing less than a radical rethink may be required. 10  Sharman (2011). BIS central bankers’ speeches  5  References Bernanke, B and Lown, C (1991), “The Credit Crunch”, Brookings Papers on Economic Activity, 1991:2, pages 205–39. Board of Governors of the Federal Reserve, “Banking and monetary statistics, 1914–1941”, page 283, available at http://fraser.stlouisfed.org/publications/bms/. Diamond, D (1984), “Financial Intermediation and Delegated Monitoring”, Review of Economic Studies, 51(3), pages 393–414. Epstein, L and Wang, T (1994), “Intertemporal Asset Pricing under Knightian Uncertainty”, Econometrica, 62(3), pages 283–322. Financial Services Authority (2011), “Proposed Regulatory Prudent Valuation Return”, Financial Services Authority, CP11/30, available at http://www.fsa.gov.uk/pubs/cp/ cp11_30.pdf. Giffords, B and Mainelli, M (2009), “The Road to Long Finance: A Systems View of the Credit Srunch”, Centre for the Study of Financial Innovation, Number 87. Haldane, A G (2010), “Fair Value in Foul Weather”, available at http://www.bankofengland. co.uk/publications/speeches/2010/speech427.pdf. Knight, F H (1921), “Risk, uncertainty and profit”, Hart, Schaffner and Marx Prize Essays, no. 31, Boston and New York, Houghton Mifflin. Laux, C (forthcoming), “Financial instruments, financial reporting, and financial stability”, Vienna University of Economics and Business. 6  BIS central bankers’ speeches  Lord Sharman of Redlynch (2011), “Going Concern and Liquidity Risks: Lessons for Companies and Auditors, Preliminary Report and Recommendations of the Panel of Inquiry”, available at http://www.frc.org.uk/images/uploaded/documents/The%20Sharman%20Report %20-%20final%200311111.pdf.