Who was at fault for setting sub-standard accounting rules that allowed UK banks to fail?

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Tim Bush does, in effect ask the above question in his paper on the failings of the IFRS with regard to UK and Irish banking and says:

The Queen asked of the banking crisis “why had no one spotted it coming?” The reason, I submit, is quite simply due to the above. A shared model that had worked in the UK and Ireland since 1879,
was replaced by another shared one that produced false profits, overstated capital, misleading creditors, misleading shareholders, the Bank of England, FSA and others.

Although IFRS had been rolled out across the EU, the UK and Ireland implemented it so extensively that the impact was different. It has been a “double dose” to the extent of being a deadly dose, by removing what had underpinned banking solvency for over 120 years. In engineering terms it was like a signalman sending a train down the wrong track. The UK had the first failing bank, Northern Rock, which only the month earlier appeared to have so much capital it applied to reduce it. IFRS merely reports the train crash rather than prevents it.

The banking crisis was systemic in the UK and Ireland, including the building society sector, despite having different currencies, different interest rates and different banking regulators. The common factor was a banking system underpinned by a Company Law Accounting Standards system since 1879, then being replaced by a new one from 2005, with one with severe faults with solvency left out. IFRS implementation cost hundreds of millions in some banks, but the real cost has been many, many multiples of that.

The root of the error is that the ASB is tasked with setting accounting standards for the purpose of the Act (which includes supporting banking solvency) and not merely “financial reporting standards” for the purpose of the EU capital market Transparency Directive from which IFRS came. A crucial difference and a fatal error. Parliament did not change the required output standard of audited accounts of banks (i.e. repealing Sections 830-837), but the ASB’s method of implementing IFRS changed the method of delivery to a sub-standard level.

The essence of Tim’s argument is a simple one and it is that UK company law has since 1879 been committed to ensuring companies are solvent. The current law is to be found in sections 830 to 837 Companies Act 2006 – and auditors have an absolute duty to understand and report on it. Tim argues that under IFRS this obligation was ignored – and worse still, the UK Accounting Standards Board facilitated that process by thinking that compliance with a flawed approach in IFRS was more important than compliance with UK company law. This is, of course, the ultimate arrogance of self regulation.

The issue of greatest importance was the recognition of provisions for bad debts. Under the UK’s accounting standards – and company law in the UK until International Financial Reporting Standards came along – prudence was required. So bad debts were anticipated and provided when reasonable doubt arose. Under IFRS this was outlawed – bad debts were only allowed to be recognised when they had gone bad. So concern was not enough. A disaster had to happen before provision was made – hence Tim’s claim that “IFRS merely reports the train crash rather than prevents it” because capital is knowingly overstated in the meantime – and reported, quite incorrectly as being true and fair.

No wonder banks fell over one after the other.

All of them helped by that other imprudence of IFRS – that a company’s debt can be revalued to market worth – meaning banks could and did take profit on its own gearing before the crash.

And who is responsible for this? The UK accounting profession – without a shadow of a doubt.