This conceptual paper discusses the impact of fair value accounting
practices on financial performance of commercial banks in relation to
the established banking theories i.e. Credit creation, fractional
reserve and financial intermediation theory. These theories are
discussed in view of historical cost accounting principles and fair
valued accounting principles considering the financial performance
during different stages of economic conditions. The analysis shows
that fair value accounting practices in banks create reserves in
economic booms improving financial performance and deteriorate
created reserves in economic downturns causing financial crises.
Enhanced financial performance in terms of unrealized gains
improves the overall efficiency of banks in view of production
approach of the financial intermediation theory. Therefore, it can be
interpreted that external factors such as accounting, infrastructure,
and technology can influence efficiency of the financial
intermediation process. This is the first study to discuss the
implications of fair value accounting on banking theory in view of
performance of financial institutions and stability of financial system.
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