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Regulators Consider Requiring Banks to Disclose More About Debt Levels

The SEC may soon be implementing rules to shed more light on efforts by banks to make their books look better — a practice known as "window dressing."

The SEC may soon be implementing rules to shed more light on efforts by banks to make their books look better — a practice known as "window dressing." Perhaps the most famous of those tactics was Repo 105, an accounting trick used by Lehman Brothers to move billions in assets off its balance sheet and hide risk from investors. Earlier this year, the SEC queried a number of banks on whether they’d used repurchase agreements — a form of short-term borrowing — in a similar way.

Attempts by banks to temporarily lower debt levels are considered window dressing when done to make a bank’s balance sheet look better to investors at the end of each quarter. Common practices such as repurchase agreements — trading assets for cash, with an agreement to repurchase those assets at a later time — can be put to this purpose. The borrowed cash also allows banks to make more investments ($).

Banks have commonly defended this practice. When we asked, Bank of America told us that “efforts to manage the size of our balance sheet are routine and appropriate.”

According to the Wall Street Journal, the practice of “window dressing” is widespread:

Financial data from 18 large banks known as primary dealers showed that as a group, they have consistently lowered debt at the end of each of the past six quarters, reducing it on average by 42% from quarterly peaks.

The practice suggests the banks are carrying more risk than is apparent to their investors or customers, who only see the levels recorded on the companies' quarterly balance sheets.

Now the SEC is considering rules requiring firms to disclose more about their short-term borrowing.

One of the ideas being considered, according to the Journal, is more frequent disclosure of average borrowings. (Banks currently have to disclose their average borrowings once a year.) That way, investors get more than just the carefully planned end-of-quarter snapshot.

The SEC will meet tomorrow to discuss the proposed disclosure rules. Its queries to the banks about repurchase agreements turned up some accounting errors by a few banks, but didn’t result in enforcement action.

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