A controversial change in accounting rules this year has allowed banks to claim billions of dollars in additional earnings simply by tweaking their bookkeeping, greatly enhancing the appearance that the industry is returning to health.
A study by an accounting expert found 45 financial firms reported higher first-quarter earnings because of the change. The total benefit exceeded $3 billion. Some large firms, including Prudential Financial Inc. and Bank of New York Mellon Corp., were able to report profits rather than losses.
But accounting rule makers are considering further changes that could potentially force banks to acknowledge paper losses even larger than the new windfall of paper gains.
The proposal has put a spotlight on the Financial Accounting Standards Board, the obscure nonprofit group that sets bookkeeping rules for U.S. companies, highlighting the extent to which important changes in financial regulations may be decided off Capitol Hill.
It also has sparked the latest round in a battle between investors eager for more information about the financial health of banks and companies eager to retain control over their image and the information they present to investors.
The debate is not just about cosmetics. In setting the rules that investors use to assess performance, the accounting board also exerts important influence on the way banks do business, which has ramifications for the broader economy.
The proposal, which the standards board will consider issuing for comment this month, would require banks to report the value of all loans and other assets based on the prices that buyers are willing to pay. This process is called marking to market, and the result is called a fair value. Banks currently are not required to report the fair value of most loans. They can instead report a value based on the original purchase price.
Some investors and accounting experts think the change would make it harder for banks to conceal problems from investors.
"Usually when someone says that something is a big deal in accounting it's because it's going to increase profits or decrease profits, and this is not going to do either. But this is still a big deal," said Jack Ciesielski, publisher of The Analyst's Accounting Observer. "It's going to show investors how much assets are worth."
Banking executives and industry groups have responded to the proposal with shock and consternation. They say banks would be forced to record large declines in the value of loans, then set aside large sums to cover the implied losses, tying up money that might otherwise support new lending.
Some industry groups warn privately that they will press Congress to intervene if the standards board moves forward with the proposal, which could trigger a broader fight over the board's future. The accounting board currently answers to only the Securities and Exchange Commission. But others increasingly have sought to influence the board, including members of Congress, banking regulators and banking trade groups.
The Financial Crisis Advisory Group, an expert panel commissioned by the accounting board to advise it, said in a report last week that its members were "increasingly concerned about the excessive pressure placed on the two boards," FASB and its international counterpart, the International Accounting Standards Board, "to make rapid, piecemeal, uncoordinated and prescribed changes to standards."