What is Banking Book Accounting?
Banking book accounting is a special way that banks keep track of their money and assets. It’s different from the normal accounting that most businesses use. Banks use banking book accounting for certain things they own, like the loans they give out and some kinds of investments.
Accrual Accounting
In banking book accounting, banks use something called “accrual accounting” for these special assets. Accrual accounting means you count the money you expect to get in the future, even if you don’t have the cash yet.
For example, when a bank gives out a loan, they don’t get all the money back right away. The person who got the loan pays it back little by little, with interest. With accrual accounting, the bank counts all the interest they expect to get over the whole life of the loan, not just the payments they get each month.
Impairment
Another important part of banking book accounting is something called “impairment.” This is when the bank realizes it might not get all its money back from a loan or investment. Maybe the person who got the loan is having trouble paying, or the investment isn’t doing as well as expected.
When this happens, the bank has to write down the value of the asset in their books. They have to do this regularly, not just at the end of the year. This helps the bank’s books show a more accurate picture of what their assets are really worth.
How is it Different from Other Accounting?
Banking book accounting is pretty different from how most businesses do their accounting. There are a couple of other methods banks use for different kinds of assets:
Trading Book Accounting
For assets the bank plans to buy and sell quickly, like some stocks and bonds, they use “trading book accounting” or “mark-to-market accounting.” With this method, they update the value of these assets to the current market price every day. If the price goes up, they count that as a profit. If it goes down, that’s a loss.
Available for Sale Accounting
For investments the bank might sell in the future but isn’t actively trading, they use “available for sale accounting.” This is kind of a middle ground between banking book and trading book accounting.
With available for sale accounting, the bank still uses accrual accounting to count the interest they earn. But they also adjust the value of the investments to the current market price, like with trading book accounting. However, they don’t count these adjustments as profit or loss right away. Instead, they put them in a separate part of their financial statements until they actually sell the investment.
Why Do Banks Use Banking Book Accounting?
You might wonder why banks use this special accounting method. There are a few reasons:
Long-Term Focus
Banking book accounting makes sense for assets the bank plans to hold for a long time, like most loans. The bank cares more about the total interest they’ll earn over the life of the loan, not the day-to-day changes in the loan’s value. Accrual accounting helps them focus on this long-term view.
Stability
Banking book accounting can make the bank’s profits look more stable than they would with mark-to-market accounting. With mark-to-market, the value of the bank’s assets would go up and down with the market, even if nothing has really changed about the loans or investments themselves. This could make the bank’s financial statements look more volatile.
Regulation
Banking regulations often treat assets in the banking book differently from those in the trading book. For example, the bank might have to hold more capital (like a safety cushion) against assets in the trading book because they’re considered riskier. By using banking book accounting for certain assets, the bank can sometimes lower these regulatory requirements.
The Downside of Banking Book Accounting
While banking book accounting has its advantages, it also has some potential problems:
Hiding Risks
Because banking book accounting doesn’t update asset values to the current market price, it could potentially hide risks. If a lot of loans are going bad, the bank’s books might not reflect this right away. This could give a false sense of security.
Manipulation
Banks might be tempted to abuse banking book accounting by classifying assets as part of the banking book when they’re really more like trading assets. This could let them avoid mark-to-market losses and make their profits look better than they really are.
Complexity
Having multiple accounting methods can make bank financial statements very complex and hard to understand, even for experts. This complexity can make it harder for investors, regulators, and the public to really know what’s going on with a bank.
