The importance of regulation

Posted by MARTIEN LUBBERINK - Oct 08, 2017

"No, Martien, there is no 'CRD for Dummies'", Laetitia explained to me when I joined the EBA sub-group on Own Funds (bank capital) in the spring of 2009. My conversation with Laetitia was one of many that we had at EBA and Basel sub-committee meetings. These meetings led to CRD II, Basel III, and its European implementation: CRD IV. 

Since that comment of my French counterpart, I realised the importance of regulations and institutions. Needless to say, during my years at the Dutch central bank (DNB), I spent many hours studying bank regulation.

Fast forward to today, here are a few things that I learned, and I hope sharing some of my experiences will contribute to the quality of European accounting research. 

Accounting academics and policy makers hardly engage with each other, this is not good. When I joined DNB in July 2008, I started working at a department that developed policies on financial reporting for banks, insurance companies, and pension funds. Our department was probably doomed: IFRS was just implemented. Any and all policy initiatives were outsourced to London (IASB), Brussels (European Commission), and the Accounting Task Force, an obscure appendix of the Basel Committee Policy Development Group.

Fortunately, the financial crisis gave our department a new lease of life. I was re-assigned to the EBA and BCBS working groups that rewrote bank capital rules. 

Although bank capital is an accounting construct, the policy groups were hardly populated by accountants. To me this was revealing as well as refreshing: the policy groups were truly multidisciplinary. I realised that policy making requires knowledge of – in particular – history, law, credit rating agencies, and tax, and only a little bit of accounting, economics, and finance. 

Group members with accounting expertise knew about local GAAP; knowledge of IFRS was sparse. I was one of the few 'accountants' in the working groups, but hey, with years of research experience only, what did I know of the inner workings of IAS 39 or IFRS 4? 

I often found myself up against colleagues who had little understanding of accounting research, or even basic stuff: the efficient market hypothesis, the usefulness of accounting information for investors, Ball and Brown, Beaver, or  Burgstahler and Dichev. 

Why these silos? I learned that, in a world dominated by lawyers and economists, accounting folks are perceived as dull and ignorant. Uh oh.

Unfortunately, the way we conduct our research does not help to abolish that stigma. Some influential accounting academics look down on regulators, which, if you think of it, is not smart. Instead of engaging with policy makers, accounting academics tend to focus on a few topics that are over-researched: e.g. earnings management, conservatism, loan-loss provisioning. A field of research that is particularly problematic for bank regulators is fair value accounting. 

Fair value accounting is not a banker's thing. DNB also had no subscriptions on the big four accounting journals. This was unfortunate: in a time when regulators dismissed fair value accounting, the lack of knowledge of accounting research hardly supported good accounting policy making. We relied mainly on SSRN. Unfortunately, my colleagues did not always understand the difference between papers of Wayne Landsman and Ross Watts: all SSRN papers carried equal weight. As a result, policy makers zoned out: the accounting literature on SSRN is far too confusing for a policy maker to understand.

In the end, bank policy makers remained unwilling to embrace fair value accounting. Their prudential genes favour conservatism, convinced that fair value accounting is a threat to financial stability. It is just too pro-cyclical. Therefore, as an accounting researcher you can try, but bank policy makers remain reluctant to give up prudence in favour of fair value accounting.

Academics, on the other hand, could pay attention to the research demands of policy makers. I realised that bank regulation is big, but manageable. See my own blog for a list of relevant regulations: the list is finite. All regulation is written in English. With a bit of effort you can find your way through CRD IV or Basel III. The easiest EU regulation is probably the 4-pager on the application of international accounting standards, the IFRS regulation.  As said, there is no for Dummies that will help you out, you have to dirty your hands.

Also note that new regulations are always consulted before implementation. These consultations often reveal gaps in the knowledge of policy makers, gaps that you can use as an inspiration for new research. Moreover, organisations like the Basel Committee and the EC publish comment letters, which also offer cues for new research.  

So, yes, I am convinced that engaging with policy makers, paying attention to their research demands, will improve the relevance and quality of accounting research in Europe. In a time when mastering research methods is hardly a burden given easy access to sites such as the Google/YouTube's econometrics academy, you may ignore regulation at your peril.

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