Understanding Investment Standards in the Banking Industry

By Green, Brian Patrick; Reinstein, Alan | The Journal of Lending & Credit Risk Management, August 1998 | Go to article overview

Understanding Investment Standards in the Banking Industry


Green, Brian Patrick, Reinstein, Alan, The Journal of Lending & Credit Risk Management


Many lending officers and managers of financial institutions trekked through their business education when investments were valued at lower-of-cost-or-market (LOCM) - a method to value investments using the conservative principle of "never overstate an asset." The systematic undervaluing of most investments was motivated by the Great Depression of 1929. Since then, investment markets, in seeking to minimize information risk when stock prices free-fall, have instituted such fail-safe features as breakers to suspend trading if the market falls too quickly. Breakers, also used to prevent recurrences of equity market instabilities of the late 1980s, appear generally to work, at least temporarily.

In 1994, SFAS Standard No. 115, Accounting for Certain Investments in Debt and Equity Securities, eliminated the historical LOCM contrivance and relied heavily on managers' proficiency to estimate a true fair market value for most investments, their capacity to assess intent, and their ability to hold such investments to maturity. Removing LOCM allows marking-up company investments to current fair-market-value, which can overstate the value of company investments, especially during periods of market instability. Effective in 1998, the AICPA's SAS No. 81, Auditing Investments, primarily seeks to offer guidance to CPAs concerning management's valuation of and intent to hold various investments. Bank managers can also apply the tools to assess their own reporting of investments.

Investments may constitute a significant amount of total assets for both banks and some businesses that use the credit that lending institutions offer. Nonservice industries, such as manufacturing and mining, often face misstatements in accounts receivable and inventory. However, banks, which normally have minor amounts of such assets, face misstatements in loan receivables and investments. Information derived from both of these account groups contributes heavily towards management's planning of the institution's liquidity projections. Overstatements give the appearance of the availability of future resources that may no longer exist. Like the loan receivable area, the recent SFAS allows flexibility in management judgment when reporting investments' final values. Institutions planning future liquidity needs can face potential risks when portfolio managers use less conservative estimates of their investments' current value.

SFAS No. 115: The Basics

SFAS No. 115 required all companies to change from a historical LOCM to a market value approach for valuing their marketable debt and equity securities. The Standard gives management much latitude in determining the expected length of its debt instruments, such as short- or long-term investments, and the marketability of all debt and equity financial instruments, even virtually bankrupt securities. SFAS No. 115 is particularly important to the banking and financial services industry, which carries large portfolios of financial instruments and evaluates its clients' financial stability. For example, infrequently traded securities can be valued at a company's book value per share, even when the last trading price or current fair market values are available.

SFAS No. 115 defines debt or equity securities as financial instruments. Equity securities investments with "readily determinable" market values and all investments in debt securities must be classified as either held-to-maturity, trading, or available-for-sale. Debt securities include U.S. Treasury bonds, U.S. agency securities, municipal securities, convertible debt, corporate bonds, commercial paper, and such secured debt instruments as collateralized mortgage obligations. Equity securities consist of an entity's ownership interest in another entity or the right to acquire or dispose of such an interest at a fixed or determinable price, including common stock, stock rights and warrants, and put and call options. Financial instruments may also include foreign currency forward contracts, loan agreements, financial options and guaranties, loan commitments, and letters of credit. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Understanding Investment Standards in the Banking Industry
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Author Advanced search

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.