Crises are when credibility becomes paramount, says Chicago Booth’s Haresh Sapra. In a financial crisis, accounting practices tend to get the blame for causing problems or making them worse. Sapra says that if banks practice fair-value accounting and use expected-loss models, they can provide the transparency necessary to demonstrate their trustworthiness to customers and the public.
It’s interesting to me that every time there’s a major crisis, people talk about accounting.
If you think of the financial crisis of 2008, what came to the forefront was something called fair-value accounting, the idea being that banks were marking to market their loan portfolios. And in fact, there were a lot of criticisms that accounting was causing the crisis, and I don’t believe it was.
At best, what was happening was that by using fair-value accounting, it was revealing the type of risks that banks were taking. And maybe that accelerated things and may, perhaps, have provided a catalyst for banks to write down their loans.
Now, let’s go back 12 years later, essentially the same thing is playing out again. There’s a feeling that accounting, the way that you do your accounting, could actually be making things worse during the crisis.
Both crises have one thing in common: In crises, it is very important that you build trust. It’s extremely important you build trust, companies build trust. And to build trust, you have to use proper accounting, being transparent. Fair-value accounting allows banks to be transparent during financial crisis, and the expected-loss models also allow banks to be very transparent during financial crisis.
That’s a message not just for accounting, but for politicians. I think it’s very important to be very transparent during a crisis time. By being transparent, you build trust in the economy, and you build trust among people. And this is precisely the time where people want politicians, not just banks, they want politicians to be trustworthy.
So, there’s a common theme to it. It’s not just accounting, but it’s just part of everyday life. Being trustworthy is probably the best medicine right now.