Fair value accounting and bank’s profitability under the adoption of IFRS: Evidence from the Scandinavian banking sector

Abstract

The research paper re-examined the internal determent's of bank's profitability with extends the literature by examining the implications of fair value accounting (FVA). Via applying GMM linear model interaction instruments, on Scandinavian banks for the period span from 2011 to 2018. Whereas, internal determinants of banks profitability models were performed in different scenarios; asset quality, liquidity, and capital adequacy. On average, "Sweden and Denmark" shows that asset quality and capital adequacy have a tendency to have a positive effect on ROAA and ROAE with FVA. The favorable results due to the impaired loans and the loan loss provision are low. While the negative effect of liquidity due to the high percentage of the asset is tied up in form of a loan. With, Norway the results reveal that FVA induces a various negative effect on bank's profitability of credit risk transfer and liquidity (reserve-to deposits, and loan portfolio) which leads to high leverage "artificial volatility" of equity funding, increase the cost of capital, and extend economic cycles over its pro-cyclical effects. Moreover, FVA has high magnitude effect on shareholder wealth. Thus, the study recommends classifying the cash flow characteristics of the financial assets based on the liquidity level, and the segments of the market that could improve long-term profitability.