Does Fair Value Taxation Affect Banks’ Investment Portfolios and Risk Taking?

Abstract

We analyze the implications of including fair value changes in taxable income on banks’ asset allocation and risk taking. Exploiting variation in fair value tax regimes and tax rates across 27 countries from 2010 to 2018, we find that fair value taxation is associated with banks’ investment portfolio choices and risk taking. On average, banks hold fewer fair-value taxed securities when fair value taxes increase. This effect is pronounced for savings and cooperative banks. Further, the effect is pronounced for banks that report under local GAAP for tax purposes. Our results also suggest that banks instead invest more in securities that are not taxed at fair value. Lastly, we provide evidence that the risk taking of savings and cooperative banks is positively associated with the tax rate when subject to fair value taxes. In addition, banks that report under local GAAP increase risk taking when subject to fair value taxes.