Bank regulators are nagging accounting standard setters. The
proposed level of interference into accounting standards is ramping up. And
while the accountancy profession has professed itself keen to play its full part
in sorting out the banking crisis, there is still a clear and growing
expectation gap between what the financial regulators want the accountants to do
and how far they are prepared to go. Accountants are adamant that financial
accounts are primarily aimed at investors: bank regulators are dismissive of
that purpose and are keen for them to be subsumed into a vigorous prudential
The latest assault on these lines came from the intellectually rigorous and
charmingly persuasive chairman of the Financial Services Authority. And Adair
Turner was confident enough of his ground to put his argument at the heart of
the accountancy establishment in a speech to the Institute of Chartered
Accountants in England and Wales.
One of the arguments bankers are deploying in the ‘it’s not my fault, guv’
analysis is that, if the standards had been better, they would have reined in
their behaviour and the crisis would not have come to pass. According to Turner,
before the crisis, there was concern among banks at board level about how low
their commercial loan loss provisions had to be to comply with accounting
standards. This would stand further investigation but it does not seem to be a
point that has been brought out clearly to date.
The argument of regulators is that the standard induced pro-cyclicality in
credit provision and pricing. Prudential regulators say this cannot happen again
so standards must reflect the belief that banks are different because, unlike
any other sector, bank failures topple the world economy into recession.
The financial sector is unique, argues Turner, because it deals in financial
instruments which link the present to the future: they have value in markets
which are ‘inherently intertemporal’. He explains that, in contrast to say,
bananas, a loan or equity contract has value today determined by future events
and by opportunities to trade future for present value by way of other financial
The resulting inherent uncertainty over how to value long-term and contingent
assets and liabilities introduces specific problems and complexities into the
regulation and the accounting of all financial intuitions.
Banks have two other peculiar characteristics which could influence the
accounting regime, however. First, the maturity transformation function in
lending at longer-term than their liabilities. Second, extending credit to the
real economy. Swings in the credit supply matter far more to the macro economy
than over supply and contraction in bananas.
If you accept banks are different, can that difference be dealt with through
a prudential approach, or does accounting have a part to play especially in
what Turner has identified as the two most contentious areas, the treatment of
loan losses and the valuation of financial instruments? Yes, says Turner,
because the present accounting approach makes the problem worse.
He says the way accounting standards should be distorted to allow the banking
book to reflect a more forward-looking approach to loans losses and second, much
more contentiously, to limit the use of fair value accounting in the income
statement to highly liquid instruments.
So where should the balance be struck between other users of banks’ financial
statement and the prudential regulators? It is tempting to be as helpful as
possible to the major players and it would be possible for the accounting
standard setters to convince themselves that what was good for the prudential
regulators was, by definition, good for all.
A few years ago, standard setters may well have crumbled in the face of the
persistent regulatory attack. But the global approach of the last few years has
made standard setters a more cohesive and tougher bunch. As Bob Herz, chairman
of the Financial Accounting Standards Board puts it, the feeling among standard
setters remains that handcuffing regulators to Generally Accepted Accounting
Principles or distorting them to always fit the needs of regulators is
inconsistent with the different roles of financial reporting and prudential
Where the needs of regulators deviate from the perceived information
requirement of investors, the reporting to investors should not be subordinated.
To do so degrades the financial information available to investors and reduces
public trust and confidence in capital markets.
Standard setters should continue to work with regulators on specific areas
such as extra disclosure and possible recasting of information, but fundamental
issues over measurement or more carve outs are off limits. Turner’s argument is
already familiar; perhaps regulators believe if they repeat it often enough they
will win the day. That, in the long run, would be a retrograde step. The
accounting profession needs to politely but firmly make it clear to Lord Turner
and his colleagues: nice try on accounting standards, sunshine but we’re not
Peter Williams is a chartered accountant and freelance