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Thursday, January 31, 2013

Bank accountants, 'going concern' statement and the need for ultra transparency

At the heart of every bank annual report is a statement by the auditor attesting to whether the bank is a going concern or not.

Like the suspension of mark-to-market accounting and the granting of regulatory forbearance to transform dud loans into zombie loans, the going concern statement has also been gamed by the financial regulators since the beginning of the financial crisis on August 9, 2007.

The financial regulators gamed the going concern attestation by promising to support the banks during the current crisis.

Clearly, the UK auditors are not comfortable making misrepresentations as they suspect that the UK government will not support the insolvent banks forever.  As a result, the UK auditors are pushing to offload the responsibility for making the going concern determination.

Regular readers know that the way to relieve the UK auditors of their discomfort is to require the banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With this information, market participants can adjust the value of the bank's exposures and determine for themselves whether a) the bank is solvent or b) the bank has the ability to generate the necessary earnings to become solvent again.

With ultra transparency, the UK auditors can rely on the market's view of whether a bank is a going concern or not.

From a Financial Times article,
Struggling banks should not use vague promises of state aid to keep investors in the dark about their fragility, according to new UK guidance aimed at avoiding a repeat of the confusion experienced during the financial crisis. 
The Financial Reporting Council said on Wednesday that bank directors and auditors should not rely on generalised words of support from central bankers or the government when deciding whether the institution remained a going concern. 
“Directors and auditors are responsible for making their own judgments about the future solvency and viability of the bank,” it said. A “nod” or “wink” implying state support was not enough, added Marek Grabowski, FRC director of audit policy. 
The updated FRC guidance follows controversial secret talks between UK bank auditors and the government at the height of the crisis. 
Companies must declare in their accounts whether they view themselves as a going concern, meaning they have enough cash and access to funding to survive for at least a year. 
They must also tell investors if there is a material uncertainty about this status, although such a disclosure would probably be so catastrophic for a bank that regulators would intervene first. Auditors verify the going concern assertion.
Requiring the banks to provide ultra transparency ends the reliance on a wink and a nod from bank regulators.

Given that the bank regulators have all said that the banks are currently solvent, one of the findings of the stress tests, now is the perfect time to have them begin providing ultra transparency as there should be no chance of a catastrophic failure by a bank when its exposure details are disclosed.

Once ultra transparency is in place, the market votes every day on whether a bank is a going concern or not.
Before green-lighting their clients’ 2008 accounts, however, UK bank auditors asked the government for broad confirmation it would continue to prop up ailing financial institutions
Lord Myners, then City minister, responded by saying the government would take “whatever action is necessary to maintain financial stability, protect depositors and protect the taxpayer”. 
The implication that banks could be described as going concerns because of the expectation of sustained state backing was subsequently ridiculed as “Alice in Wonderland” logic during House of Lords hearings....
However, banks have in fact received sustained state backing since the beginning of the current financial crisis.
The FRC ... is trying to meet the needs of investors for candid information without undermining confidence in the banking system.
Ultra transparency both meets the needs of investors for candid information and improves confidence in the banking system.

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