Banks Need Bespoke Accounting Rules, BoE Says

by Jason Gorringe, Tax-News.com, London

25 January 2012

Andrew Haldane, the Executive Director for Financial Stability at the Bank of England, has called for a rethink of reporting requirements for the banking industry, due to inconsistencies in how banking assets are quantified when the market value is unknown.

In the text of a speech delivered to the Institute of Chartered Accountants in England and Wales's 'Information for Better Markets' conference in London last month, and only just released by the Bank, Haldane noted that during times of economic vitality, accounting standard setters have pushed for banks to adhere to 'fair value' reporting rules while “as the crisis tide has turned, with falling asset prices and failing banks, so too has the fair value debate".

Fair value reporting is a method of identifying the market value of an asset when the market price cannot usually be determined, an issue prominent in the banking sector.

Haldane noted that: “In 2008, under intense pressure from an ailing banking community, the Financial Accounting Standards Board and the International Accounting Standards Board eased back on fair value accounting rules. For example, banks were allowed to switch financial instruments from trading to holding to avoid mark-to market requirements,” allowing them to avoid reporting regular asset value fluctuations.

Haldane said:

“Historically, fair value accounting principles have gained ground when the going has been good, and lost it when it has got tough. From a financial stability perspective, this is a cause for concern. To see why, consider how banks’ balance sheets then appear to investors. During the asset upswing, fair value gains ground. Mark-to-market gains are booked as profits. To the extent that asset prices are over-inflated, so too are the recorded profits of the banks.”

“During the downswing, fair value principles are rolled back. Potential losses are then hidden from view. Today, some of the uncertainty around global bank valuations stems from the difficulty in gauging these losses, obscured by provisioning practices in banking books. Regulators and investors alike fear the fog created by such forbearance.”

“As the financial crisis began unfolding in 2007, policymakers called for an easing of the 'fair value' rule so that banks don't have to price all their assets immediately at values that were falling fast, making them unstable and in need of bailouts by taxpayers.”

"In sum, accounting rules in general, and fair value principles in particular, appear to have played a role in both over-egging the financial upswing and elongating the financial downswing. They have tended to over-emphasize return in the boom and under-emphasize risk in the bust. That is not a prudent approach. Indeed, it is a pro-cyclical one. We need accounting rules for banks which are crisis-neutral, valuation conventions for all seasons."

Haldane urged that the starting point for accounting standard setters should begin with a recognition of “the clear differences between bank and non-bank balance sheets, in particular valuation uncertainty associated with assets and maturity mismatch associated with liabilities".

To push forward the debate, the Bank of England has recently helped initiate a program to enhance information on the valuation of banks' fair-valued assets, working alongside the Financial Services Authority (FSA) and the auditing profession. A framework for capturing such uncertainty was put forward in an FSA consultation paper on “Proposed Regulatory Prudent Valuation Return”, published in December 2011.

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