The Wall Street Journal has reported that several large banks hid their risk levels for the last five quarters, according to the statistics from the Federal Reserve Bank of New York.
About 20 banks, including J.P. Morgan Chase & Co., Morgan Stanley, Goldman Sachs Group Inc, Citigroup Inc. and Bank of America Corp. hid the actual debt that they had taken for funding trading in securities. They used to temporarily lower their debts at the end of each quarter when banks have to publicly disclose their debt data and then they increased their debt levels again in the next quarter.
This effectively hides the risk that is being taken by the banks in the long run.
One of the main reasons for the economic recession was seen as too much indebtedness of banks, which seems to have led the banks to now hide their real levels of debt and risk in order to protect their stock prices and credit ratings. This misleads investors about the risk involved in dealing with instruments issues by that institution. However, the banks claim that this practice is perfectly legal. Major banks involved in this practice say that their filing documents clearly state that the borrowing levels vary in a quarter.
By taking debts, banks can trade without the need of putting too much of their own funds. This is also used in the ‘repo’ or repurchase market for getting short-term financing. The practice increases the risk, magnifying gains when the market is strong, and resulting in huge losses when the market falls. This had led to the crash of several banks like Lehman Brothers in 2008.
Data show that the unpaid net repo borrowing was around 40% lesser at the end of last five quarters from the maximum borrowing level during each quarter. The SEC is getting details of repos from major financial institutions as a recent investigation revealed that Lehman had used repos to hide its debt. Accounting guidelines may also be announced to prevent hiding of repos, debt levels, and the risk being taken by banks.
The need to prevent banks from indulging in practices that help them in hiding their debt and risk levels was felt after the recent financial crisis. Although such practices have been going on for a long time, there are now calls for urgent reform of accounting practices and public disclosure rules.