FASB’s Statement No. 133 on Derivatives and Barings Bank: The Case for Value at Risk (VAR)

Spectacular bankruptcies of the Orange County Investment Pool in December 1994 and Barings Bank in February 1995 mounted a pressure on the U.S. Financial Accounting Standards Board (FASB) to issue Statement No. 133, Accounting for Derivatives Instruments and Hedging Activities (FAS 133). Although measuring derivatives at fair value is a major improvement in accounting for derivatives, such type of accounting falls short of quantifying and reporting the risk of losses associated with derivative instruments. The purpose of this paper is to suggest an alternative approach to market valuation by integrating quantitative market risk estimation into the valuation method. The paper will use the Barings Bank experience to demonstrate how FAS no. 133 disclosure falls short of disclosing the magnitude of the market risk held by the bank at the end of 1994. It will also demonstrate how using a risk‐impacted value would have improved the disclosure of how much the bank stood to lose from their open positions.