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Window dressing refers to actions taken or not taken prior to issuing financial statements in order to improve the appearance of the financial statements.Here is an example of window dressing. A company operates throughout the year with a negative balance in its general ledger Cash account. (Its balance at the bank is positive due to the time it takes for its checks to clear its bank account.) Since the financial statements report the Cash amount appearing in its general ledger account, the financial statements would report a negative amount of Cash. However, the company does not want its December31 balance sheet to report a negative cash balance, since it will be reviewed by many outsiders. To avoid reporting a negative cash balance the company does not make the payments for amounts that should be paid between December26 and December31. This postponement of payments allows its book amount of Cash to temporarily be a positive amount. Then on January2, the company issues checks for all of the amounts that normally would have been paid at the end of December
The practice of banks ‘window dressing’ their balance sheets in the month of March may soon be a thing of the past. In its first bi-monthly monetary policy statement, the RBI said it plans to put in place measures to curb such a practice.
The central bank said, “Liquidity conditions have tightened in March, partly on account of year-end ‘window dressing’ by banks, though an extraordinary infusion of liquidity by the Reserve Bank has mitigated the tightness.
“The Reserve Bank will propose measures to reduce such practices.”
RBI Governor Raghuram Rajan pointed out that towards the end of the year banks try to build a certain kind of balance sheet.
“Different reasons are driving different banks (to go for window dressing). Some want to reduce the size of their risk-weighted assets so as to qualify for lower capital requirements.
“Others want to increase the size of their assets to meet Government performance requirements. It varies,” said Rajan.
The Governor observed that these distortions (window dressing) do affect a variety of markets. For example, the Certificate of Deposit (CD) market became very tight starting in February itself and so the RBI took some pre-emptive steps to improve liquidity.
Rajan said, “But in the longer term, we think the RBI should not be in the business of bailing out the banking system with infusions of liquidity when the banking system itself is creating its own problems.
He observed that year-end should not be a time for anything special to happen. It should be smooth.
A strategy used by mutual fund and portfolio managers near the year or quarter end to improve the appearance of the portfolio/fund performance before presenting it to clients or shareholders. To window dress, the fund manager will sell stocks with large losses and purchase high flying stocks near the end of the quarter. These securities are then reported as part of the fund's holdings.
Investopedia explains 'Window Dressing'
Performance reports and a list of the holdings in a mutual fund are usually sent to clients every quarter. Another variation of window dressing is investing in stocks that don't meet the style of the mutual fund. For example, a precious metals fund might invest in stocks that are in a hot sector at the time, disguising the fund's holdings, so clients really have no idea what they are paying for.
Window dressing may make a fund appear more attractive, but you can't hide poor performance for long.
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