Costs rise when failed banks lack financial transparency

Costs are lower and bidders are helped significantly more when failed banks have more financial **transparency.

** In the world of finance, business, and markets transparency refers to the extent to which all stakeholders have ready access to a company’s data.

Professor João Granja at the Massachusetts Institute of Technology reported their findings, titled “The Relation between Bank Resolutions and Information Environment”, in the Journal of Accounting Research.

Squeaky-clean accounting is not just a sign of a well-run firm. Granja’s study of the banking industry demonstrated that transparent accounting helps secure stability when banks collapse, and can even reduce costs for customers and taxpayers when the government has to intervene.

Governments have had to intervene a lot since the financial crisis of 2008. The US government was forced to intervene as the liquidating agent for over 300 banks from 2008 to the end of 2010.

Financial transparency led to higher bids and cheaper liquidations

Professor Granja found that banks with superior disclosure practices received significantly higher bids for their assets. Regulators reported that banks with transparent accounting were much cheaper to liquidate.

Failed banks that have filed documents with the Securities and Exchange Commission (SEC) on average see a much higher proportion of their assets purchased by other companies during bankruptcy biddings, because potential purchasers are better able to understand and trust the value of their assets.

Prof. Granja said:

“More transparency reduces information asymmetry, making bidders more willing and more confident about bidding for these assets.”

Regulators report that financial institutions that had regularly filed SEC documents were 4.5 percentage points cheaper to handle in bankruptcy compared to less transparent banks.

Transparency saves bidders a lot of time

The more transparent banks are easier for outside parties to analyze – they do not have to waste time searching around in an effort to determine the true state of the bank’s books.

Granja adds “There is a social benefit here. It’s less costly for the regulators to close it, [costs that] ultimately might actually fall on the taxpayer.”

Financial transparency helps depositors and buyers

The Federal Deposit Insurance Corporation (FDIC) administers bank bankruptcies in the US. It is mandated by Congress to seek out the cheapest means of administering bankruptcy proceedings. Customers, such as bank depositors want their bank, if it fails, to do so in a quick and orderly manner.

When a financial institution fails “They [the FDIC] immediately want to close it and sell it to a healthy bank, so that there’s no unrest for the depositors,” Granja points out.

Bank bankruptcies are not all the same

Banks are regulated by several different agencies. However, those registered with the SEC undertake “a sizeable increase in financial transparency,” Granja notes. They have to register regular analysis and discussion of their activities in their annual reports, and also have to file forms with every unscheduled but materially significant event.

Granja gathered and examined data from 322 failed bank auctions between January 1st 2008 and December 31st 2010. The sales of assets of failed banks typically occur during the last two weeks before they are set to close, and bidders have only a few days to carry out due diligence, making past financial disclosure all the more significant.

Hence, Granja found 86% of assets sold among banks that had regularly filed SEC documents, compared to just 80% among the less transparent ones.

Granja said “When the failed bank was more transparent, bidders are willing to take on a higher percentage of the assets of the failed bank.”

More transparency would help stabilize markets for the next crisis

Financial crises come in waves. American economic history is littered with waves of failing financial institutions, a phenomenon that was acute in the 1980s, and then again during the 2008-2010 period.

Granja suggests that studying best practices for bankruptcy proceedings may help calm the financial waters during the next crisis.

When the FDIC needs extra funding because its costs have suddenly risen, something that nearly always happens during financial crises, customers and taxpayers have to foot the bill. Greater transparency by financial institutions today could subsequently protect citizens from future costs.

In an Abstract in the journal, Granja concludes:

“The results suggest that disclosure regulation policy influences the cost of resolution of a bank and, as a result, could be an important factor in the definition of the optimal resolution strategy during a banking crisis event.

Leave A Reply

Your email address will not be published.