No. 29: Accounting Enforcement and Bank Transparency under Hierarchical Supervision in a Banking Union

Abstract

Supervisors frequently intervene in banks’ financial reporting practices. Existing literature robustly demonstrates that strict supervisors enhance bank transparency. However, many supervisory frameworks are hierarchical, involving multiple supervisors with varying objectives. In cases where bank reporting relies on management discretion, such as loss estimation or asset valuation, these supervisors potentially differ in their assessment of the most adequate accounting choice. Even if the central supervisor is strict, it is unclear how the coordination with more lenient local supervisors affects banks’ reported accounting figures. The European Banking Union offers one such setting with multiple supervisors involved in accounting enforcement. Upon adoption of the Banking Union, the European Central Bank (ECB)’s Asset Quality Review revealed the preferred valuation of assets by the new central supervisor. The ECB’s valuation preferences deviated from many banks’ actual reporting choices, despite the latter being compliant with IFRS and accepted practice by the local supervisor. While we observe an adaptation of banks’ financial accounting to the non-binding preferences of the central supervisor, there is substantial variation across jurisdictions with different local supervisors. The effect is particularly weak when the fundamental reporting objectives of the central and local supervisors are misaligned and particularly strong when combined supervision plausibly mitigates regulatory capture. Overall, the reporting changes are associated with greater informativeness of banks’ provisioning. Our findings underscore that supervisory influence in a multi-layered supervisory system extends beyond the assurance of formal compliance with accounting standards and plays a critical role in shaping bank transparency.