Delayed handling of losses can destabilize financial systems, according to new research by Vienna University of Economics and Business.

The study, conducted by Professor Christian Laux and his co-authors, investigated the disclosure and accounting for credit risks and credit losses.

They found that late and incomplete information on losses and risk positions by banks exacerbated problems in the 2008 financial crisis.

“Our analyses shows that banks disclosed their critical positions and possible losses very late. The evidence fits the hypothesis that unreliable and incomplete disclosures can lead to a loss of confidence that poses a threat to financial systems,” says Professor Laux.

The researchers also found that regulation and accounting introduced to stabilize the financial system can actually have the opposite effect and have undesirable consequences.

“Politicians, regulators and commentators have criticized banks’ financial reporting as the cause of problems in the financial crisis. The results of the study do not confirm the widespread fear that loss disclosure was a major cause of problems for banks. Rather, it shows that many banks are actually hesitant to report losses,” says Professor Laux.

The researchers say that the results of the study are important for the recent debates on regulation and financial reporting of banks, for a sustainable and stable financial system.

Jannis Bischof, Christian Laux, and Christian Leuz: Accounting for financial stability: Bank disclosure and loss recognition in the financial crisis, Journal of Financial Economics 141(3), 2021, 1188-1217.

https://www.wu.ac.at/en/research/wu-researchers/rom21/christian-laux