Why accounting matters: A central bank perspective

Abstract

This paper analyses how accounting frameworks can affect three important areas of responsibility of many central banks, namely monetary policy, financial stability and banking supervision. The identified effects of accounting rules and accounting information on the activities of a central bank are manifold. First, the effectiveness of monetary policy crucially hinges on the financial independence of a central bank, which can be evidenced, inter alia, by its financial strength. Using a new simulation of the financial results of the European Central Bank (ECB), this paper shows that the reported annual profit and financial buffers of a central bank can be significantly affected by accounting, profit distribution and loss coverage rules. Second, in respect of financial stability, the accounting frameworks applied by commercial banks can not only affect their behaviour, but also that of financial markets. Indeed, there is evidence that accounting frameworks amplified pro-cyclicality during the recent crisis, and thus posed risks to the stability of the financial system. This being so, the accounting frameworks of credit institutions have obvious implications for central banks' analyses with regard to promoting financial stability. Finally, as regards banking supervision, regulatory reporting and key supervisory ratios are based on accounting data. Under the new regulatory framework for banks in the European Union (EU), bank supervisors are highly reliant on accounting data. This means that central banks, in their role as bank supervisors, need to understand the underlying accounting rules and should directly support the development and application of harmonised accounting frameworks.