James M. O'Brien

The limitations of market value accounting and a more realistic alternative

Abstract Market value accounting (MVA) might improve market and regulatory discipline on financial institutions. Unfortunately, there are serious conceptual, measurement, and incentive problems with implementing MVA that have not received significant attention. These problems are suggested by the theory of asymmetric information and the role intermediaries play in solving information and monitoring problems. After analyzing the problems with MVA, we develop an alternative approach that applies MVA principles where they are most feasible and uses a statistical procedure where asymmetric information problems make MVA particularly problematic. An empirical analysis suggests that this procedure may substantially improve the distribution of regulatory discipline.

Estimating the value and interest rate risk of interest-bearing transactions deposits

A valuation model is developed within an interest rate contingent claims framework to estimate NOW account and MMDA premiums and interest rate risk for a sample of commercial banks. As has been previously done, bank deposit rate and balances dynamics are represented by autoregressive processes but with attention given here to alternative specifications and to the deposit rent processes and dynamics implied by these specifications. Alternative deposit rate specifications studied include asymmetric adjustment to market rate changes. In examining the implied deposit rent processes, special attention is given to the importance of distant rent forecasts and forecast dynamics for the deposit premium and interest rate risk estimates.

Bank Commercial Loan Fair Value Practices

Recent accounting changes, for the first time, permit the use of fair value in the primary financial statements for held-to-maturity (HTM) bank loans. While the use of fair value has historically attracted significant discussion and debate, there is little information in the public domain on how banks would measure fair value or use it in loan management. This study presents and analyzes results from in-depth discussions with seven large internationally-active banks on their fair value use and measurement for HTM commercial loans and commitments. The objectives of the discussions and those of the study are to: identify the extent to which fair value is used for HTM commercial loan facilities and how it is used; describe valuation methodologies used and consider the roles of market price sources and modeling and their relative importance in fair value estimation; consider model validation and price verification; draw conclusions as permitted and suggest areas for future research.

Equity underwriting risk

Risk in securities activities such as underwriting and dealing has become of increasing interest as the separation between commercial and investment banking erodes. In January 1989, the Federal Reserve permitted commercial bank holding companies to engage in limited amounts of corporate securities underwriting and dealing and has recommended to Congress the removal of the Glass-Steagall separation of commercial and investment banking. As banks expand their securities powers, the associated risks have a policy significance because of deposit insurance and the safety net provided to large commercial banks by the federal government. Furthermore, understanding the risks associated with underwriting and dealing can be important in understanding what determines the demand for these services. In this study we examine equity underwriting risk within the context of earlier work on price risk associated with equity offerings and underwriting risks over time.