Differences and interactions between banks’ financial statements and prudential regulation

Abstract The article analyzes the dichotomy between banks' financial statements and prudential regulatory requirements. While financial statements should be true and fair, prudential regulatory requirements focus on banks' soundness, riskiness and risk management practices. The lessons learned from the 2008 crisis have brought about significant changes in both bank accounting and banking regulation, which have led to a major transformation in both areas. Their development is characterized by a number of contradictions, differences and mutual interactions. In this article, we analyze three areas of European bank accounting and regulation that were of particular relevance to the 2008 crisis and the subsequent regulatory changes, and which are crucial for both today's bank accounting and banking regulation. These are as follows: the differences in the application of fair valuation of financial instruments; the issue of impairment accounting; and the differences in equity and regulatory own funds. We have identified different patterns of interaction across the three areas and have identified a number of areas for further research.