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June 28, 2010

Comments

Dane Morrison

Typical financial institutions try to produce a partial hedge on their interest rate risk by carefully balancing the repricing terms of the liabilities and the assets. Revaluing only the asset side to the market will distort the balance sheet, particularly when interst rates become volatile.

Until both sides can be marked to market, it is better to shore up the existing methods of accounting for credit risk (e.g. use of environmental factors) rather than setting only half the balance sheet ot fair value.

Credit risk is the concern today, but interest rate risk will be back again some day. If we are going to fix the balance sheet, fix both sides!

Edward Beale

Mark to market of financial instruments is in principle the right approach for minority of companies that are financial institutions, where in the main those financial instruments are their "working capital".

However, the accounting standards also apply to the vast majority of companies that are not financial institutions and where the financial instruments are mainly investments or financing (outside of treasury operations where they are "working capital").

The problem with the debate on accounting standards for financial instruments is that it is totally driven by the needs of financial institutions, overlooking all the other companies that are affected.

We really need two sets of financial instruments standards, one mark to market for shorter term working capital items and one for more long term investments (where fair value is a guess unless the investment is publicly traded) and financing (where the timing of gross cash flows is key).

Alternatively financial institutions should have their own separate standards.

Howard Lothrop

Even if interest rate hedging occurs organically through matching the repricing of assets and liabilities, the full interest rate risk component of the loan will still represent a counterbalancing offset to the cyclical credit shift.

For example, in the above-mentioned economic downturn, as credit factors act to depress loan prices, lowered interest rate will act to increase (fixed rate) loan values. Similarly, in an expansion as credit spreads narrow (loan values increase), interest rate increases will act to limit this gain. So, the impact is not without some offset.

Finally, even if the mark-to-market component is somewhat volatile, regulatory capital need not (nor is it now) equal accounting capital, so bank regulators have tools to allow some slack here.

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