Mark To Market Accounting
There have been many advances in the field of credit management. Mark to market accounting is one such innovation. Mark to market accounting is now commonly used by many organizations to manage their credit risks. In this article, we will understand what the concept of mark to market is and how it helps in managing credit risks.
What is Mark To Market?
Mark to market is a way of recording and valuing the loan assets on the balance sheet of the lender. Traditionally, loans made by lenders were held on the books at book value. However, there was a problem with this approach. The book value does not reflect the decreased credit quality over a period of time. Hence companies often valued their investments at a higher value even though they were being traded at a lower value in the market.
Mark to market accounting was created as a solution to help resolve this problem. Mark to market simply means that the value of the asset on the balance sheet of the lender is changed periodically to reflect the new market realities. For instance, if a bond was purchased for $100 but its present market value is $90, then the company will be forced to adjust the $100 value to $90. As a result, the net worth of the company will be reduced by $10!
Before implementing mark to market accounting, a time period has to be decided when the valuation will be updated. For instance, companies generally decide to mark the value of their positions to the market at the end of each trading day. The price which will be used for valuation also has to be clearly defined. For instance, the closing ask price at the end of the day will be used for valuation.
Advantages of Mark to Market
There are several known benefits of using the mark to market approach. Some of these benefits are as follows:
Disadvantages of Mark to Market
The mark to market accounting model has also faced several criticisms from the financial community. Some of them have been listed below:
It would be fair to say that mark to market is a valuable instrument which if used correctly can aid in credit risk management. However, it is important for companies to be aware of the possible risks and ensure that they are avoided.
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