Tuesday, April 10, 2012

Investors take on banks over 'true and fair' reporting

In her Guardian column, Jill Treanor highlights how Pension & Investment Research Consultants (Pirc) has a fundamental problem with current accounting rules which allow the banks not to disclose a 'true and fair view' of their position.

Regular readers know that current accounting rules reflect the choice by policymakers to adopt the Japanese model for handling a bank solvency led financial crisis.  Under the Japanese model, financial regulators bless accounting that facilitates banks hiding losses on an off their balance sheets.

Pirc is advising its clients to vote against the annual report, its auditors (PricewaterhouseCoopers) and non-executive director Sir Michael Rake (who chairs the audit committee) because it believes that accounting rules allow Barclays to overstate the amount of profit it generates. 
And Pirc is not just singling out Barclays as it intends to tell its clients to vote against the auditors of HSBC and bailed out Royal Bank of Scotland, again because of its concern over the accounting rules.
Stephen Hester has already confirmed that Royal Bank of Scotland is using accounting to hide its losses.
It is an attempt by Pirc to highlight what it regards as a fundamental problem with accounting rules – known as International Financial Reporting Standards (IFRS) – which Pirc argues allows banks not to provide a "true and fair view" of their position as required by the Companies Act but instead take a "backward look" on their assets and liabilities. 
As complex as this debate is – and IFRS is an internationally adopted standard – Pirc has calculated that the IFRS methodology allows RBS to overstate its profits and capital by £16.8bn, Barclays by £6.7bn and HSBC by $16bn (£10bn). 
These calculations are based on Pirc's view that IFRS allows banks to overvalue loans compared with a realistic assessment of what they might get back, leave out some bonus payments and benefit from changes in the prices of their own debt. 
Of course, the only way to know how much the accounting statements are overstated by is by requiring the banks to provide ultra transparency and disclose their current asset, liability and off-balance sheet exposure details.

With these details, market participants could adjust bank book capital so that it reflects the 'true and fair view' of the bank's position.
This debate over accounting standards has rumbled on since the 2008 banking crisis – the banks clearly believe they are complying with the rules – but one that Pirc, at least, is not going to allow to go away.
The banks should believe they are complying with the rules as they went to the policymakers and financial regulators and lobbied them to adopt the Japanese model over the Swedish model for handling the banking crisis.

As a result of their lobbying, the banks now have accounting rules that let them invent any financial statement they would like (for example, Level 3 securities are marked to what management believes they are worth).

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