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May 18, 2009

Grant Thornton US offers fair value solution

(FREE) The solution to the fair value debate lies in changing the way regulatory capital requirements are established, rather than changing accounting standards, Grant Thornton US has told banking regulators.

Grant Thornton made this proposal to the US Treasury, the Federal Reserve System Governors and the Federal Deposit Insurance Corporation in a letter intended to expound on a proposal that has been talked about in some accounting circles.

The core of the message is that regulators already have the ability to require banks to increase the amount of capital they hold without changing the financial statements, Grant Thornton managing partner of public policy and corporate governance Trent Gazzaway said.

If they did this in line with Grant Thornton’s proposal, it would increase regulatory capital requirements in booming economies, which would serve as a braking mechanism for banks, preventing them from investing in riskier assets by removing the available capital.

This capital would be held as a reserve that would be available in a market downturn for banks to use to maintain normal lending operations.

Gazzaway suggested the increased capital requirements would also attract investors looking for long-term value and safety.

“Those are the kind of investors we want in financial institutions that have systemic risk because they don’t put the same pressure on management for short term earnings,” he explained.

Gazzaway said there is a lot of pressure on the Financial Accounting Standards Board to make changes to accounting so the effects will flow through to regulatory capital.

“We are saying that doesn’t have to be the case,” he said. “The minute we start making changes to accounting standards, we are impacting the clarity of the information to investors.

“Right now the ability exists for the regulators to make changes on their side without impacting accounting. They should exercise that ability and what that will do is take the pressure off the accounting standard setters to make changes that aren’t necessary for operational purposes.

“We are not trying to insert some regulatory or legal separation between accounting standards and regulatory standards, we are just trying to highlight the separation that already exists and is available now. We can capitalise on that and get to that win-win situation where both the investors have the information they need and the regulators have the tools and the ability to protect the safety and soundness that they need.”

Gazzaway said the crux of the issue is the question ‘is US GAAP having a negative impact on regulatory capital?’

“I would say that in large part, ‘no’,” Gazzaway said.

He explained that the mark-to-market of most assets that are subject to fair value does not impact regulatory capital.

Most assets in the US are held in the category ‘available for sale’. These are classified as trading assets and that mark does not impact regulatory capital, he said.

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