Do loans fair value affect market value? Evidence from European banks

Purpose - With reference to IAS/IFRS, the purpose of this paper is to examine the value relevance of the two amortised cost/fair value measurement methods applied to loans, and test whether loan fair values are an incremental explanatory factor for a bank's stock price, beyond that provided by loan book values. Design/methodology/approach - The value relevance of 83 European banks from 2005-2008 is analyzed. The authors employ a regression model in which the stock price (dependent variable) is related to accounting variables typically affecting the firms' market value (book value and earnings). Findings - Book values and earnings affect banks' market values. Investors appreciate the difference between loan book and fair values, and attribute to this difference an expected negative value. Furthermore, the control variable for banks headquartered in countries most affected by the financial crisis proves to be strongly significant as the crisis dummy variable itself. Research limitations/implications - The results have important implications for bank managers, who should consider the importance that financial markets attribute to loan fair values. There are also implications for regulators and standard setters, though these are less obvious. Originality/value - This is the first study on the explanatory power of loan fair values in Europe. It addresses loan fair values, and the European market, while previous literature has mainly concerned the US market. In addition, the authors use an original dataset containing information on the loan fair values of European banks during a timeframe which covers both pre-crisis and crisis periods.