IT WOULD be a ‘mistake' to impose a separate set of accounting standards on banks, according to the Big Four.
Carving out separate reporting rules for the UK's largest banks could lead to "accidental arbitrage" and the creation of a shadow banking system, auditors told a House of Lords committee hearing yesterday.
Members of the Big Four appeared before the commission on Banking Standards, where they were grilled by former chancellor Lord Lawson on the role of auditors and accounting standards in the financial crisis.
Addressing the panel last week, Stella Fearnley, professor of accounting at Bournemouth University expressed horror at the "deathly silence from the accounting establishment about some of the dysfunctional outcomes" from IFRS.
But yesterday the Big Four were unanimously against the idea of carving out a separate set of rules for the banks. John Hitchins, UK banking and capital markets leader at PwC, said such a move would "not be appropriate".
"A lot of transactions of a banking nature are done by non-banks...you run the risk of creating a lot of accidental arbitrage. The principles in the accounting standards are all perfectly applicable to banks," he said, but added there is a "good argument" for having something specific for banks is in the way risk is disclosed.
Such arbitrage would "drive transactions to a shadow banking market" suggested David Barnes audit partner at Deloitte; an argument initially dismissed by Lawson because shadow banks would not be systemically important.
However, Mike Ashley, head of risk at KPMG Europe, argued that the big banks would inevitably be involved in funding the market, which would be systemically important "in the same way that AIG Financial Products [the credit default swap division of the US insurer] had great ramifications for the banking system when it looked close to failure."
Ashley added that having a different regime for banks would be a "mistake" and that current accounting standards for financial instruments are clearly aimed at banks.
"It's much better to have accounting standards for different types of products," he said.
Tail wagging the dog
Providing consultancy services to audit clients is an area of potential conflict of interest, Lawson said, adding that a disparity between the profitability of audit work and consulting services was a cause for concern because "we have the tail wagging the dog because audit is a critical function that is in the public interest".
However, the Big Four denied one service was inherently more profitable than the other and, in any case, there are already a number of checks and balances that govern the work auditors can do for their clients to "prevent clear conflict".
"If there was a tax judgment that was dependent on an accounting treatment where the amounts were material we couldn't give tax advice related to that," said John Preston, PwC's global tax policy leader; while Jane McCormick, head of KPMG's tax and pensions practice in the UK, added that financial institutions have tended to limit the consulting work they give to auditors.
"Very often it is simply more trouble for a financial institution to use its auditor to give tax advice than it would be just to hire one of the competitors," she said.
Nevertheless, John Cullinane, tax partner at Deloitte, suggested that the profession would be comfortable if an "iron rule" was imposed to prevent auditors providing tax consulting to clients.
Call of duty
One of the reasons for the failure of auditors, institutions and regulators to spot the impending banking collapse was a lack dialogue between the three parties to challenge the common assumptions that risks to the banking system had been eliminated.
Lawson put forward previous suggestions that auditors owed a duty of care to the regulators, which should be imposed on the market. The panel of auditors largely agreed that some form of duty of care was necessary, but couched that with various caveats.
Hitchins at PwC said their primary duty of care had to remain to the investors, while Ashley said auditors needed to be "careful" what the duty of care was in respect of.
"I'm not sure it's appropriate to have it in respect of the financial statements work we do," he said.
Tony Clifford, Ernst & Young's global IFRS financial instruments leader, went further and suggested that a formal duty of care would not make much difference to the quality of dialogue between auditors and regulators.
"For dialogue to work well it has to be on an informal basis. Quite often to make sure the regulator can...shut the door before the horse has flown [sic] the auditor cannot wait until they have a fully formed understanding of what is going on," said Clifford.
The professional bodies were more relaxed about dialogue being enforced. Speaking earlier in the day, Robert Hodgkinson, executive director, technical, at the ICAEW said the institute was "quite relaxed" about mandatory dialogue but added that regulators must actively open up "discussion to think the unthinkable".
"If everyone shares the same point of view that actually there aren't any big problems on the horizon you can mandate as much dialogue as you like but you're not going to surface issues. Part of the reason why that dialogue lapsed was because people though there wasn't enough to talk about," he said.
The commission hearing kept returning to the failings on IFRS in exacerbating the banking collapse, and in particular the use of a "deeply flawed" incurred loss model for loan provisioning and the removal of the prudence form the IASB's conceptual framework.
According to Lawson, the IASB's decision to "abandon the touchstone of prudence and replace with neutrality" in order to drive forward accounting convergence with the US, was "with the wisdom of hindsight at the very least was a stupid thing to do".
However, Chas Roy-Chowdhury, head of taxation at ACCA, responded that the concept of prudence is still very much alive.
"In terms of the conceptual framework prudence isn't in there but in terms of the underlying basis in which you apply the IFRS standards it very much is still there...it hasn't disappeared at all," Chowdhury said.
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