We thank Jessica Keeley and Saptarshi Mukherjee for excellent research assistantship on the empirical and modeling/Appendix sections, respectively, of this essay. We thank Christian Leuz for extensive initial discussions regarding the scope and topic matter of this essay as well as extensive comments on the pre-conference outline and draft. We also thank Gauri Bhat and Dushyant Vyas for useful comments on the pre-conference draft. Banks' Financial Reporting and Financial System Stability

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... T The use of accounting measures and disclosures in banks' contracts and regulation suggests that the quality of banks' financial reporting is central to the efficacy of market discipline and nonmarket mechanisms in limiting banks' development of debt and risk overhangs in economic good times as well as mitigating the consequences of those overhangs with the potential to compromise the stability of the financial system in downturns. This essay examines how research on banks' financial reporting, informed by the financial economics literature on banking, can generate insights about how to enhance the stability of the financial system. We begin with foundational discussion of how aspects of banks' accounting for financial instruments, opacity, and disclosures may affect stability. We then develop a simple model of fair value and amortized cost accounting with regulatory forbearance that illustrates the complex interactions that can result among banks' accounting treatments, investors' willingness to fund banks' assets, the incentives of banks and investors to gamble, and regulators' policy of bailing out banks. We then evaluate representative papers in the existing empirical literature on banks' financial reporting and stability, pointing out the research design issues that empirical accounting researchers (still) need to confront to develop well-specified tests able to generate reliably interpretable findings. We then provide examples of settings amenable to addressing these issues. We conclude with considerations for accounting standard setters and financial system policymakers.