Do Large European Banks Differ in their Derivative Disclosure Practices? A Cross‐Country Empirical Study

AuthorSalvatore Polizzi,Enzo Scannella
Date01 January 2019
Published date01 January 2019
Do Large European Banks
Differ in their Derivative
Disclosure Practices? A
Cross-Country Empirical Study
Enzo Scannella and Salvatore Polizzi
The use of
derivative instruments
is widespread among
banks and other
nancial institutions.
Potentially, it is a sig-
nicant source of sys-
nancial system. This
increases the impor-
tance of an accurate
derivative disclo sure
in banking, particu-
larly with respect to
the ongoing turmoil
in the banking and
nancial systems.
Derivative disclosure
is essential for banks
stakeholders to evalu-
ate the banksrisk
exposures and to
make decisions. It is
crucial for stake-
holders that an
adequate amount of
information about
exposures does not
remain within the
boundaries of
the bank.
Risk disclosure in
banking contributes
to reduce asymmetric
information among
stakeholders (Akerlof,
1970; Leland & Pyle,
1977) and agency
problems (Fama,
1970, 1980; Fama &
Jensen, 1983; Jensen &
Meckling, 1976) that
ent interests between
a principal and an
agent in the economics
and management of
banks. In this perspec-
tive, risk disclosure in
banking is an incentive
device (Armstrong,
Risk disclosure has stra tegic importance for the
efciency of nancial markets and overall nan-
cial stability. It plays a pivotal role in strengthen-
ing market discipline and b uilding trust to
improve relationships with stakeholders in bank-
ing. Risk reporting has taken a growing impor-
tance in banking over the last years. The topic of
this article is derivative reporting in banking. The
authors employ content analysis to conduct an
empirical study on a sample of large European
banks. The authors propose a hybrid scoring
model for the assessment of derivative disclo-
sure in banking institutions. The methodology
employed in this research is able to capture a
considerable amount of information because it
combines the characteri stics of a quantitative
and qualitative analysis. This article provides evi-
dences that banks differ in their derivative
reporting, although they are subject to similar
regulatory requirements and accounting stan-
dards. This empirical an alysis shows that there
is room to improve various aspects of derivatives
disclosure in banking and poses some questions
Refereed (Double-Blind
Peer Reviewed)
© 2019 Wiley Periodicals, Inc.
Published online in Wiley Online Library (
DOI 10.1002/jcaf.22373
Guay, & Weber,
2010; Dobler, 2008) to
align divergent inter-
ests, and offers an
opportunity to
improve the functions
of screening, selection,
and monitoring
(Diamond, 1984) per-
formed by depositors, investors,
and other stakeholders. In addi-
tion, risk disclosure performs a
signaling function for the market
(Foster, 1980; Leland & Pyle,
1977; Ross, 1977).
Risk disclosure, and deriva-
tive disclosure particularly, is
also connected to the cost of
capital of the bank. There is a
substantial relationship
between risk disclosure and
cost of capital. Risk disclosure
might result in reduced costs
of capital (Botosan, 1997;
Botosan & Plumlee, 2002;
Healy & Palepu, 2001; Leuz &
Verrecchia, 2000). Derivative
disclosure in banking is also
central to the efcacy of mar-
ket discipline and nonmarket
mechanisms in limiting banks
development of debt and in
mitigating the adverse conse-
quences for the stability of the
nancial system (Acharya &
Richardson, 2009; Acharya &
Ryan, 2016; Core, 2001;
Crockett, 2002; Financial
Stability Board, 2012; Freixas &
Laux, 2012; Malinconico,
2007; Nier & Baumann, 2006).
A better knowledge of deriva-
tives in banking should
enhance both transparency and
stability in the nancial mar-
kets. Moreover, although sev-
eral studies already shed light
on the importance that disclo-
sure has for several kinds of
risk in banking industry
(Beattie & Liao, 2014; Beattie
et al, 2004; Beretta &
Bozzolan, 2008; Dowd,
Humphrey, & Woods, 2008;
Jorion, 2002; Linsley &
Shrives, 2005), it is crucial to
recognize that derivative expo-
sures might lead to serious
losses for banks, if this kind of
nancial instruments are not
managed properly. Hence, the
analysis and the methodology
proposed in this article might
contribute in closing the loop on
this eld of study, because a
complete and clear disclosure on
market, credit, and other kind of
risks would be almost useless if
banks do not provide an ade-
quate amount of information
about their derivative exposures.
Derivative instruments are an
enormous potential source of
risk for banks; therefore, a satis-
factory disclosure on other kind
of risks might be completely
spoiled by an inadequate
reporting on derivative exposure.
Furthermore, derivative disclo-
sure is notably affected by nan-
cial innovation and nancial
engineering, which is a never-
ending process. Thus, since the
contributions on this topic are
not very recent (Chalmers &
Godfrey, 2000; Venkatachalam,
1996; Wang et al, 2005; Woods
& Marginson, 2004), it is
straightforward to understand
the importance of the topic of
this research article.
In this article, we make an
empirical study on derivative
disclosure on a sample of large
European banks. Hence, this
article investigates the quality of
derivative disclosure in banking
with reference to the Interna-
tional Accounting Standards
IAS/IFRS, the Pillar
3 disclosure require-
ments of the New
Basel Capital Accord,
and the national regu-
latory framework for
banksannual nan-
cial statements.
In this article, we employ a
content analysis to evaluate the
quality and quantity of deriva-
tive disclosure in banking.
Content analysis is a methodol-
ogy that has been used by sev-
eral researchers to examine and
evaluate risk reporting in
annual reports, as a research
technique for making replicable
and valid inferences from texts
to the contexts of their use
(Krippendorff, 2004), and as
a research technique for the
objective, systematic and quan-
titative description of the mani-
fest content of communication
(Berelson, 1952). Over the
years, content analysis has been
applied to a variety of scopes
(Holsti, 1969; Weber, 1990).
By using a scoring model
based on key disclosure param-
eters, this article provides evi-
dences that banks differ in their
derivative reporting, even
though they are subject to simi-
lar regulatory requirements and
accounting standards. Our
research also shows that there
is room to improve various
aspects of derivative disclosure,
discusses some policy and theo-
retical implications, and pro-
vides some useful insights for
further research.
The structure of this article
is as follows. Section 2 intro-
duces derivative disclosure in
banking. It aims to frame the
specic nature of derivatives,
and provide a regulatory and
accounting perspective of
derivative disclosure in bank-
ing. Section 3 proposes a
hybrid-scoring model based on
that researchers may develop with further empir-
ical analysis. This article also discusses the
potential policy implications of the research nd-
ings for practitioners, bank regulators, and
accounting standard setters. © 2019 Wiley Period icals, Inc.
The Journal of Corporate Accounting & Finance January 2019 15
© 2019 Wiley Periodicals, Inc. DOI 10.1002jcaf

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