Fair value accounting practices in the banking industry: a possible opportunity to launder money through manipulated performance
| DOI | https://doi.org/10.1108/JMLC-06-2021-0064 |
| Published date | 11 August 2021 |
| Date | 11 August 2021 |
| Pages | 893-908 |
| Subject Matter | Accounting & finance,Financial risk/company failure,Financial compliance/regulation,Financial crime |
| Author | K.L. Wasantha Perera,Roshan Ajward,Sisira Dharmasri Jayasekara |
Fair value accounting practices in
the banking industry: a possible
opportunity to launder money
through manipulated performance
K.L. Wasantha Perera
Department of Finance, Faculty of Management Studies and Commerce,
University of Sri Jayewardenepura, Nugegoda, Sri Lanka
Roshan Ajward
Department of Accountancy, Faculty of Management Studies and Commerce,
University of Sri Jayewardenepura, Nugegoda, Sri Lanka, and
Sisira Dharmasri Jayasekara
Financial Intelligence Unit,
Central Bank of Sri Lanka, Colombo, Sri Lanka
Abstract
Purpose –The purpose of this paper is to discuss the possible money laundering threats in fair value
accounting practices giving particular attention to the list of predicate offences under recommendations of
FinancialAction Task Force (FATF).
Design/methodology/approach –This paper discusses case studies related to global accounting
scandals and link outcomes of those scandals with the list of predicate offences given in FATF
recommendationsto build propositions.
Findings –The analysis reveals that legal proceedings on major accounting scandals show that legal
proceedings have been restricted owing to a lack of evidence because of the technicality of frauds.
Often the authorities have failed to prove cases under the list of current predicate offences which can
be linked to accounting malpractices, i.e. fraud. Therefore, policymakers are required to revisit the list
of predicate offences and the feasibility of considering accounting malpractices as a predicate offence
to strengthen the corporate governance practices in regulatedinstitutions. The adoption of fair value
accounting practices provides opportunities to managers to adopt earnings management practices
under a fair value accounting regime to maintain stable performance. The fair value practice
recognizes unrealized gains which are not based on transactions giving bank managers an
opportunity to repeat the outcomes of the discussed accounting scandals. Therefore, it is essential to
criminalize accounting malpractices to strengthen the corporate governance practicesin the banking
industry and prevent possiblea ccountingscandals.
Research limitations/implications –This study was designedto discuss the implications of fair value
accounting practices on possible opportunities of money laundering. This paperprovides only a viewpoint
based on the analysis. Therefore, an empirical analysis is requiredto establish the authors’views in a fair
value accountingregime.
Originality/value –This paper is an originalwork done by the authors which discuss the implicationsof
fair value accounting practiceson possible money laundering. The views are original ideas of the authors in
this context.
Keywords Money laundering, Earnings management, Predicate offences, Fair value accounting,
Value information
Paper type Viewpoint
Fair value
accounting
practices
893
Journalof Money Laundering
Control
Vol.25 No. 4, 2022
pp. 893-908
© Emerald Publishing Limited
1368-5201
DOI 10.1108/JMLC-06-2021-0064
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1368-5201.htm
1. Introduction
The regulators ofthe banking industry adopt a stringent licencing regimeand fit and proper
requirements to prevent criminals from owning and holding key management positions of
banks. On the other hand, the banks are also required to develop a comprehensive
mechanism of customer due diligenceto prevent criminals from using the financial system
of a country. These two aspects consider the external forces to a bank that can exploit the
financial institutionsfor criminal activities, i.e. for money launderingand terrorist financing.
However, some internal forces can also influence banks for criminal activities. The largest
global business scandals show that one of such forces is accounting malpractices. For
example, Freddie Mac, one of the two government-sponsoredenterprises that dominated the
secondary market for home mortgages, was embroiled in a controversy over improper
accounting methods in 2003.These improper practices had intentionally misstatedearnings
of US$5bn and understated on the books. Jickling (2007) revealsthat Freddie Mac has used
some of its accounting policies to produce a steady stream of earnings, and numerous
transactions wereundertaken for the sole purpose of smoothing out reported earnings.
The accounting malpractices of American International Group (AIG) during 2000–2005
is another one of the largest accountingscandals which had a severe impact on analysts and
investors. The company allegedly booked loansas revenue, steered clients to insurers with
whom AIG had payoff agreements and told traders to inflate AIG stock price. In this case,
the Securities and Exchange Commission alleges that from at least 2000 until 2005, AIG
materially falsified its financial statements through a variety of sham transactions and
entities whose purpose was to paint a falsely rosy picture of AIG’sfinancial results to
analysts and investors (Securities and Exchange Commission vs. American International
Group Inc,2006). The collapse of Lehman Brothers in 2008 is another example where the
company hid over US$50bn in loans disguised as sales. Allegedly sold toxic assets to
Cayman Island banks with the understanding that they would be bought back eventually,
created the impression that Lehman had US$50bn more cash and US$50bn less in toxic
assets than it did. The companyused a repurchase agreement (Repos 105) to manipulate the
financial statement of the company, the Lehman balance sheet in June 2008 was fabricated
with window-dressing technique popularly referred to as Repos 105 which led to the
removal of US$50bn in commitment from their financial statement (Mawutor, 2014). The
above examples show that different accounting practices or malpractices influence
the reported performance of financial institutions. Therefore, this study focuses on
discussing the impact of differentaccounting practices on the performance of banks in order
to identify mal-accounting practices as a predicate offence for money laundering in view of
strengtheningcorporate governance practices in banks.
2. Implications of different accounting practices on performance
The reliability and accuracy of the disclosed financialinformation depend on the accounting
principles adopted by the banks. Historical cost principles provide the most reliable and
accurate financial information, and fair value accounting principles provide relevant up-to-
date information with less reliability and accuracy. The literature on accounting studies
explains that accounting practices are used in the earnings management of institutions
(Greiner, 2015;Šodan, 2015;Mergaerts and Vennet, 2016). On the other hand, fair value
practices provide up-to-date information. Duarte et al. (2008) show that fair disclosure of
information affects the cost of capital of firms. The fair value financial disclosures also
provide fair disclosure with current information, and therefore, it will affect the cost of
capital of banks and performance. Earnings management is a very popular area in
accounting related studies. However, value information disclosure in respect of fair value
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