The Bank of England issued a statement yesterday saying that the UK's major banks and building societies are currently underestimating their losses by £50 billion.
I think that's true.
But why didn't they say as a result that the accounts of the banks in question are not true and fair?
Or that they cannot have been properly audited as a result?
And that this crisis is in no small part the fault of the Big 4 auditors who signed those accounts off and who in very large part helped set the rules under which those accounts were prepared that were written by the International Accounting Standards Board, of which they are major funders?
Why is it that when auditors have so very obviously failed completely and utterly in their duty we just turn a blind eye?
Or appoint them to chair H M Revenue & Customs?
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And we trust them to continue, and eventually wind-down, QE?
There is no reason to wind down QE
Ok, and we trust them to continue QE?
The market value of the banks (share price) would fall further.
As it is the share price is not even equall to the book value in most EEC Banks.
This would then lead to even less confidence in the deposits held by the Banks (note Cyprus). Also the debt funders would require better yields from Bank and Soverign debt.
As Martin Woolf (FT yesterday) says the Euro is not the same value in each country but only a reflection of each Central Bank and Soverign’s ability to pay back the deposits held.
The Bank of England therefore keeps quiet. After all Moore gate and Threadneedle street are next to each other. Collusion comes to mind.
Are you comparing like-with-like though? As far as I understand it, the BoE has asked for increased capital to cushion against future losses on a stressed scenario. Whereas the financial statements would be prepared under IAS 39 which would require provisions for losses that have already been occurred, using the best estimate of loss.
Now, this may change with the latest IASB moves to start reflecting future expected credit losses, but (and I don’t defend auditors often) in this case it would appear that the accounts would not be IFRS-compliant if one were to provide for future losses.
But accounts were and should be prepared on an anticipated loss basis as happened to 2005
Then we would not be in this mess
And under UK company law – which still applies – these accounts were not legal as they meant the companies were not solvent but claimed they were
“And under UK company law — which still applies — these accounts were not legal as they meant the companies were not solvent but claimed they were”
But none of these underestimated losses of £50bn would make any of the banks insolvent, merely that they would have capital levels below the future required Basel 3 levels. The big four banks have capital of £300bn. While I agree that banking accounting should make provision for future expected losses, it was the regulators that moved away from this over the past decade, not the banks who loved having it in order to income smooth.
No capital = no business = insolvency
So the banks have collectively overpaid corporation tax of about £12bn, on profits they shouldn’t have recognised?
Banks have paid remarkably little tax
But you’re saying that the remarkably small amount is still £12bn too much?
Respectfully – you know you’re being a pedant – tax provisions are not tax deductible
No: provisions are deductible on an accounts basis unless there is legislation to disallow them. There is no rule disallowing loss provisions of this sort: bad debts are pretty much the exemplar of deductible provisions.
In practice HMRC also question the accounting basis of provisions, and argue that they shouldn’t have been booked in the first place. They’ve done that a bit more since FRS 12 came out, because they’ve taken to regarding FRS12 as the touchstone. But they have to argue about the accounting because there’s no tax rule they can use to disallow them.
Wrong
Nope: absolutely correct.
Have you been keeping your CPD up to date since Herbert Smith v HMRC came out? HMRC have been quoting FRS 12 to me ever since.
Sorry, I just realised you said “tax provisions”. Of course tax provisions aren’t deductible, they’re below the line. But the £50bn isn’t tax provisions, it’s loss provisions: those are above the line and would normally be deductible.
Wrong: no specific provision could be made
The Revenue can still reject on the basis of lack of certainty
Herbert Smith was a specific provision
The general/specific divide went out with FRS 12, though I know a lot of people still use it as a rule of thumb.
HMRC’s position is that if it’s good enough for accounts it’s good enough for tax, absent a particular tax rule. I’ve had this agreed by them many a time.
And I am aware it is challenged
And since I am saying FRS 12 is wrong it would have been in this case
Also, if the Big 4 are successfully sued beyond their PI level, then there won’t be any audit firms left with the capacity to audit major institutions ( financial or otherwise). That’s no reason of course not to hammer them, but it helps to explain why they don’t get hammered as they should do.
Sir,
The statement by the bank in itself constitutes an allegation that the audited financials are not reflecting the correct position. Woudln’t it be enough reasons for the Apex body of Accounting and Auditing to take regulatory and disciplinary measures or call for information from the Auditors to explain their position?
But they won’t, will they?
Doesn’t this also mean that the BoE has been complicit in covering this up through QE? The money multiplier effect is dubious anyway, but leaving that aside, if the BoE knew that banks have a £50 billion black hole then any belief that they’d do anything with QE monies (or indeed any other source of government money) other than hold on to it must have been obvious from the outset. It follows therefore, that the aim of QE was not, in fact, to ‘lubricate’ the economy but to plug the black hole. It also follwos that presenting it as otherwise was simply a smokescreen to mask the true (i.e. even more dire than admitted) state of bank losses. Have Osborne and Cable known this all along?
You may well be right
Although it does not explain all £375 bn
Capital is a liability of a bank, QE money is an asset of the bank, unfortunately, you can’t use QE to boost your capital.
If the BoE had used QE to buy banking assets from the banks, rather than gilts from the wider market, this would have had the effect of reducing the banks risk weighted assets and boosting their capital ratio.
But that wouldn’t have provided cheap funding for the deficit, which lets face it, is the primary purpose of QE in the UK.
Profit made using QE is a bottom line issue
I don’t understand your point.
IFRS says you provide for losses on one basis; the Bank of England is saying that if you were to provide on a more prudent basis the loss provisions may be higher and has quantified the possible extent of that increase at £50bn.
So the range of exposure is up to £50bn more than is used in the accounts, but this is not news. If a bank were to provide at the top of the range, then:
a) it would be quite rightly challenged for not following GAAP, and
b) it would be paying much less tax (about £12bn at current rates) if the losses were anticipated.
I’m not au fait with the details of banking regulation, but to me it simply seems that the Bank is saying that when calculating a risk cushion you should take into account more losses than when you’re assessing profitability. That seems eminently sensible.
I also think that having the banks pay tax on the £50bn, which is what IFRS is doing, seems eminently sensible too.
IFRS is not consistent with UK law on this
UK law requires a solvency over-ride
With provision made this would have been challenged
The accounts may have been deficient on this basis and so might the audits have been
The Companies Act explicitly permits the use of IAS.
Which bit of UK law requires you to over-ride that, and says you can’t use IAS when determining solvency?
The true and fair over-ride which requires the auditor check that a company is solvent
I’m sorry Richard but you are not correct on this – both the Companies Act and IFRS (at present) are clearly understood to require losses to be reflected on an “incurred” rather than an “expected” basis. Anticipated losses can only be reflected to the extent that they reflect conditions existing at the balance sheet date – my guess is that in current conditions (and given the way bankers now get a large proportion of their pay in shares) is that most UK bankers have been as agressive as they can be in anticipating losses in recent years – so as to get the losses out of the way and to get lots of cheap shares.
Given that under the Basel rules capital requirements are now meant to be based on expected losses – my concern is that the hawks within the BofE are rather overegging the pudding by making the UK banks hold too much capital and hence limiting their ability to fund any recovery that may occur.
And I am saying that the rule is wrong!
How hard is it to understand that IFRS was clearly a rigged accounting system ?
So if the auditors are following the rules, how are they turning a blind eye and failing in their duty?
Or, rather: how can they have a duty which is not set out in auditing standards, GAAP, or company law?
Because the auditors and IASB are connected parties
Sorry, I don’t follow. Do you mean that they’re all in cahoots so the audit opinions should be disregarded?
No, I mean the audit opinions were not objective
Alternatively, call them negligent
And in part because they created ab auditing environment that permitted that
And they may sue me for saying so
Richard – the rule is the same under the Companies Acts/UK GAAP re expected losses as it currently is under IFRSs. Some banks before IFRSs came tried to do their loan loss provsioning using expected loss models – they were told very firmly by the Revenue/DTI/auditors/lawyers that they couldn’t. IFRS is changing to require expected losses, but only with a 12 month time horizon for unimpaired loans and the whole expected loss fro those that are impaired. It is far from clear that UK GAAP/Companies Act will change similarly. But IFRSs are ahead of UK GAAP on this one I’m afraid.
The better area of attack on this for auditors is IFRS 7 – where most banks are not disclosing their own management measures of credit risk exposures even though there is a requirement to do so. Given that bank’s managements report expected loss measures to the FSA for capital purposes – I think that they would be hard put to argue that senior management did not use such measures for credit risk management and hence that they should be reported under IFRS 7.34(a). The same argument would also apply with regard to the liquidity risk and market risk measures that are also reported to the FSA.
Wow – you must be young or have remarkably little knowledge of accounting
UK GAAP requires anticipated losses be provided and was universal to 2005 in this country and is still legal – pelinator please note
IFRS s imprudent and does not allow this
It is on of many reasons why it is a flawed counting system
But let me assure you – your argument u just wrong – and wildly so – especially for saying anticipated loss was frowned on – it was demanded and rightly so
Pellinor,
I’d suggest keeping quiet on the tax point. Neither you, nor I, know how much tax banks actually pay bearing in mind transfer pricing & all their CFCs etc. It would be silly to suggest their “profits chargeable to CT” bears any resemblance to what they actually pay CT on.
So, to get to the main point, do you agree with Richard that the bank’s A/Cs are fraudulently overstated by approx £50bn ?
Not sure I follow what you are saying here.
The initial post states the auditors have not done their job, but your most recent comment states that “the rule is wrong!”
Surely auditors should be applying the rules as they stand? We would be in a awful place if every auditor had to decide on which rule to apply when.
If it is the rule that is wrong, then is if hardly right to attach those applying the rules. Blame the rule makers
(I agree that the rule is dumb, btw. Not being able to provision correctly for losses you expect to come in your loan book is hardly sensible)
Nonsense
Auditors express judgement
Companies apply rules
If the rules give the wrong result auditors have to say so
They didn’t
Richard,
I think this is a fantastically &, indeed, scarily important point which is getting overlooked because the vast majority of us laymen can’t begin to follow all the stuff about GAAR, IFRS, IAAB etc.
My understanding, & please correct me if I’m wrong, is that our banks are sitting on massive amounts on property loans both commercial & domestic which, TBH,are not going to get repaid, ever, unless there is another property boom, (which seems unlikely since, unlike the US, Ireland, Spain etc prices haven’t fallen to a sensible level from the last boom).
Now, I’m an old man & in the old days my accountant always told me that profits should never be anticipated, losses always should & that was what you called prudency. (I should add that my old accountant used paper ledgers, smoked a briar pipe & if I’d asked him for an avoidance scheme would’ve spat his vile tobacco in my face).
Have we “moved on” from that ? &, if so, do you think that a bad idea ?
Everything accountants once valued – that made them a profession – had been torn to shreds by 2000 in pursuit of the god profit
It’s why we have a GAAR coming
And why anticipated loss is having to be reimposed on a profession that has completely forgotten prudent judgement
It typifies neoliberal capitalism as a result
The Times reports today although the Financial Policy Committee has made this suggestion, the BoE has stopped short of demanding stricter capital requirements after lobbying by the Banks, a senior civil servant, and the Treasury.
So the bankers get away with it, yet again.
And I’m still not sure why you object to a system that you think over-states taxable profits. It seems an odd way to rig it.
It does not overstate taxable profits
You are simply wrong
It overstates profits
But for tax losses are always on a realised basis
Ed note: comment deleted as misleading to readers
It distorts trading, not taxable, profits. The taxable profit is the trading profit minus reductions attributable to tax avoidance scams common in the sector. Heads they win, tails everyone else loses.
That’s not the whole truth
OK It’s not he whole truth, merely a useful first approximation. One might aver that the taxable profit is the trading profit minus legitimate deductions [and if there’s anything left [there ought to be in the case of banks]] minus deductions attributable to tax scams [inevitable in the case of banks].
This is strange. Following the law/rules is not negligence. If one does not like the law/rules, by all means change them. Otherwise this is all a bit of lashing out.
You completely miss the point
UK law says the auditors must ensure the accounts are true and fair – which means they must be solvent
That over-rides IFRS
They weren’t solvent
Therefore they were not true and fair
Evidence on this has been accepted by the House of Lords
As usual, I am right
Sounds as though we have conflicting laws/regulations. Maybe a bit of harmonisation is called for?
my suggestion is the law should prevail as I, Tim Bush nd Prem Sikka argue
Auditors ignored it
Still seems a bit of a mash-up, different governing bodies issuing differing rules. Could probably use a bit of tidying up and harmonisation for clarity.
Precisely the point i have been making
Precisely mine as well. A dog’s dish of laws/regulations put forth by an alphabet soup of departments. Since nobody can make heads/tails of them due to their contradictory nature, ‘negligence’ is a long stretch.
So what are they taking fees and signing off reports for?