Abstract:
This conceptual paper discusses the impact of fair value accounting practices on 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 performance in terms of efficiency during different stages of economic conditions. The
analysis shows that fair value accounting practices in banks create reserves in economic booms improving efficiency
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 the intermediation 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 banks and stability of financial
system.
