Bank auditors need to go above and beyond

According to the House of Lords, auditing in the UK is rotten. The Lords’ committee inquiry has plunged the knife deeply into the heart of the auditing profession over its response to the banking crisis. The committee is unimpressed with the response to their questions from senior partners at Deloitte, KPMG and PwC, the auditors of large British banks. It clearly thought the auditors should have spotted things going wrong in 2007 and 2008, and sounded the alarm. In particular, it believes the auditors should have been more concerned about the business models which, now with perfect hindsight, it sees were so unsustainable. Responding to the evidence the committee heard from the global firms, it said simply that it does not accept the defence that bank auditors did all that was required of them. That defence does appear disconcertingly complacent. It may be that the Big Four carried out their duties properly in the strictly legal sense, but we have to conclude that, in the wider sense, they did not.

It is not made explicit what exactly the committee thought the auditors should have done above and beyond their legal duty, though it did disagree with the auditors on their approach to, and judgement of, the going concern of the banks in question. The auditors are rebuked for taking into consideration all possible sources of funding, including that of the UK taxpayer. The committee says this should have been ignored: “It cannot, or at least should not, be taken for granted by auditors that banks in difficulties will be bailed out by the authorities and the taxpayers.” Let us leave aside the implicit idea that auditors now somehow share bankers’ moral hazard. Instead, let us remind the committee that banks in distress were shepherded into mergers or bailed out by governments across the developed world to the tune of billions. Maybe we need a more nuanced going concern report, but the auditors were spot on. The other key criticism centres on the idea that we could have accepted the existence of an audit market oligopoly in exchange for a good product. As the output of this oligopoly has been disappointing, says the committee, it should be broken up. But it is not a deal of which I was ever aware.

Time will tell what the real impact of this report will be. Remember: it is intended to be about the whole audit market, not just the bank auditors and the financial crisis. The authors have designed it to resonate down through history – why else start the report with a reference to a House of Lords report of 1849?

 

 

In contrast to the committee’s onslaught on the point, competency, courage and character of auditors, I recently had two different but equally instructive conversations. The first was with a senior banker. He said that the care and attention auditors on the ground give to every accounting judgement that he and his colleagues make are exhaustive. He thinks bank auditors are all over their clients like a rash, and that the adherence to accounting and auditing standards could not be higher. Whatever word you could ascribe to the auditors with whom he deals, complacent does not do it for him. Nor does the accusation of a lack of scepticism.

The second conversation was with a senior partner of one of the professional services firms. No longer an auditor, he pointed out that the Big Four are increasingly less reliant on their audit divisions. Those in charge of strategy at the big professional services firms may well conclude, from a thorough reading of this report, that the benefits they undoubtedly accrue from audit work are outweighed by the hassle of public opprobrium which the House of Lords, among others, is stirring up.

Perhaps the Big Four – independently, of course – may decide it is time they retreat from certain parts of the audit market altogether. That would increase competition in a way no report could achieve. Whether such an action would ultimately be in the best interest of the capital markets is another question.

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