Fair Value Accounting, Financial Stability, and Pro-Cyclicality: Evidence from Nigerian Banks During Stress Periods

This study provides a comprehensive empirical analysis of the relationship between fair value accounting, financial stability, and pro-cyclical risk amplification in Nigerian commercial banks during periods of economic and market stress. Fair value accounting, requiring financial instruments to be measured at current market prices, has been extensively debated as a potential amplifier of financial cycle volatility. During downturns, fair value write-downs reduce regulatory capital, potentially forcing asset sales that further depress prices in a destabilizing feedback loop. This question is particularly important for Nigerian banks, which hold significant Level 2 and Level 3 financial assets including government securities, interbank placements, and equity investments. This study uses quarterly balance sheet data for 15 commercial banks from 2010 to 2023, covering three stress episodes: the 2014 to 2016 oil price crash, the 2020 COVID-19 shock, and the 2022 to 2023 foreign exchange crisis. Fair value exposure is measured using the composition of the fair value hierarchy in bank balance sheets. Pro-cyclicality is assessed through the correlation between fair value adjustments and systemic risk indicators. Panel vector autoregression and local projection impulse response methods are applied. Results establish that fair value accounting significantly amplifies pro-cyclical balance sheet dynamics during stress periods, particularly for banks with high Level 2 asset concentrations. However, fair value disclosure improves market discipline in tranquil periods. The study contributes an original Nigerian banking pro-cyclicality measurement framework and recommends countercyclical provisioning rules calibrated to fair value loss severity.

Keywords: fair value accounting, pro-cyclicality, financial stability, Nigerian banks, IFRS 9.