Bank of England backs investor campaign on banks’ IFRS losses

A report from the Bank of England suggesting that Britain’s four largest banks could require up to £35bn in new capital to account for potential loan losses has validated an investor campaign, which includes many RI stalwarts, that publicly flagged up weaknesses in international corporate accounting valuations for the banking sector. The Bank’s latest Financial Stability Report published yesterday (November 29) warned that Barclays, HSBC, Lloyds Banking Group and Royal Bank of Scotland may have understated potential losses on current loans by between £5bn and £35bn and would need to raise capital as a result. The mooted losses are due to provisions within IFRS accounting standards that mean banks do not have to account for potential future losses until they are realized by clients, which can sometimes take a considerable time to occur. A group of 10 institutional investors with €340bn in assets, including the Universities Superannuation Scheme (USS), the Local Authority Pension Fund Forum and the UK National Employment Savings Trust (NEST) last week published an open letter calling on regulators to look at the issue. They said current accounting standards failed to give significant attention to “prudence” in financial reporting and meant investors could not challenge company executives on realistic reported numbers. Significantly, the signatories said they believed the same accounting holes could also apply to other sectors outside banking, potentially leaving investors on the hook for losses in cases where banks and other companies have already paid dividends or management bonuses based on figures that may not reflect the ‘true and fair’ financial health of a company asrequired by regulation such as the UK Companies Act. The investor group recently met with Michel Barnier, the EU Commissioner responsible for internal market and services, which is currently reviewing the role of auditing firms in signing off corporate accounts. Commentators have suggested that audit firms could face legal action over the issue. Indeed, Anglo Irish Bank reportedly began legal action against its former accountant Ernst & Young yesterday (November 29), over audits of the lender’s financial returns in the years leading up to Ireland’s financial crisis and the bank’s nationalisation in 2009. Ben Levenstein, Head of UK Equities at USS said: “The gravity of some investors’ unease about the international accounting framework is a serious concern which must be addressed.” Sir Mervyn King, Governor of the Bank of England, said the UK Financial Services Authority (FSA) would “begin to take action immediately” to assess the value of banks’ assets and to set how much extra capital lenders will need to cover any new losses. The latest investor moves on accounting standards follow a concerted effort around broader audit issues such as mandatory rotation for auditors that investors have been pushing.
A campaign by pension funds and institutional shareholders to pressure the European Union to tighten up regulation of the ‘big four’ audit firms has been gathering signatories and lobbying hard in Brussels ahead of key EU rule changes expected in the coming months.
Link to RI story