Banks, Risk, and FAS105 Disclosures

Abstract

This study examines whether Statement of Financial Accounting Standard No. 105 (FAS105) footnote disclosures of off-balance-sheet financial instruments and derivatives provide risk-relevant information in addition to that provided by the balance sheet alone. A theoretical model relates market and industry risk measures to FAS105 disclosures. Empirical tests of the model reveal that these disclosures do provide risk-relevant numbers although the results are not uniformly strong. The balance sheet financial instruments explain 42 percent of the variation in market risk and 45 percent of the variation in industry-level risk among 499 U.S. commercial bank holding companies. FAS105 disclosures of off-balance-sheet instruments and derivative positions explain an additional 5 to 7 percent of the variation. Stronger evidence is presented that shows that certain controversial classes of derivatives are not associated with increased levels of market and industry-level risk. This latter evidence stands in contrast to the current notion that derivative contracts, especially interest rate and currency swaps, increase overall bank riskiness. Results also corroborate the FASB categorization of classes of financial instruments along two important risk dimensions: credit risk and market risk.

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