The Value Relevance of Risk Disclosure: An Analysis of the Banking Sector

Abstract

The aim of this study is to test whether financial risk disclosures required by IFRS 7 and Pillar 3 are value relevant for investors to support them in their investment decisions. The sample in the study consists of banks listed on the London, Paris, Frankfurt, Madrid, and Milan Stock Exchanges over an 8-year period, from 2007 to 2014. Based on the aforementioned standards, we built financial risk disclosure indexes and distinguished different risk categories, qualitative and quantitative, as well as credit, liquidity, and market risk. Our analyses confirm that there is a positive association between bank value and several categories of established risk disclosures. Furthermore, it suggests that disclosure adds value to more traditional risk value measures. Besides, our results suggest that investors pay attention to the strength of the bank authority when using risk disclosures.

Keywords:

• value relevance
• IFRS 7
• Pillar 3 Basel II
• banking sector
• transparency
• risk disclosure
• European market

Subject classification codes:

• JEL code G21
• M21
• M41

Acknowledgements

The authors appreciate comments on earlier versions of this paper from participants at the 7th EIASM Workshop on Accounting & Regulation, Siena (Italy), in 2016, and the 40 th Annual Congress of the European Accounting Association, Valencia (Spain), in 2017.

Disclosure Statement

No potential conflict of interest was reported by the author(s).

Notes

1 Pillar 3 of Basel II (BCBS, 2004) sets out disclosure requirements in relation to capital structure and adequacy (both in qualitative and quantitative terms), as well as risk exposures and assessment processes. Risk management objectives and policies have to be detailed for each separate risk area (e.g. credit, market, operational, banking book interest rate risk, equity).

2 The area of provisioning is a good example of this as highlighted in Giner and Mora (2019).

3 The overlap between both standards is explicitly admitted by the IASB in the Basis for Conclusions of IFRS 7: ‘This guidance is consistent with the disclosure requirements for banks developed by the Basel Committee (known as Pillar 3), so that banks can prepare, and users receive, a single coordinated set of disclosure about financial risks’ (IASB, 2005b, BC41).

4 The primary goal of a bank regulator is to ensure sound and prudent bank management, as well as the overall stability, efficiency, and competitiveness of the financial system, while those of a market regulator is the regulation and control of securities markets, including accounting and auditing matters, the supervision of audit firms, and the recommendation of auditing and accounting standards. See Appendix B for further details on these institutions in the countries under study.

5 EU countries had to comply with the Basel II rules from January 2007, as they were legally bounded to that after the EU passed the Capital Requirements Directive in September 2005. Nevertheless, some banks delayed the implementation till 2008.

6 See www.imf.org.

7 Thus, Bischof (2009) uses a sample of 8 French, 12 German, 14 Italian, 10 Spanish and 8 British banks in 2006–2007; Agostino et al. (2011) consider a larger sample of 34 French, 30 German, 31 Italian, 14 Spanish and 17 British banks in an earlier period 2000–2006; Barakat and Hussainey (2013) have 4 French, 7 German, 14 Italian, 6 Spanish and 8 British banks in 2008–2009–2010; Manganaris et al. (2015, 2016) use 25 French, 10 German, 31 Italian, 14 Spanish and 9 British banks; Siregar et al. (2016) consider 5 UK banks in 2008; Duru et al. (2018) use 18 French, 9 German, 20 Italian, 14 Spanish and 9 British banks in 2001, 2003, 2007, 2012; Jones et al. (2018) analyze 10 French, 9 German, 17 Italian, 6 Spanish and 5 British banks from 2006 to 2010, and García Osma et al. (2019) consider. 18 French, 6 German, 17 Italian, 5 Spanish and 8 British banks for a larger period 2000–2013.

8 We have excluded Rpower because it has the same value (see Table 1) for all the examined countries.