Turner's P&L proposal spooks audit experts

The Turner report on banking regulation could require international accounting rules to be rewritten and force auditors to justify their valuation of bank assets and provisions to regulators, experts have said.

The report by Lord Turner, chairman of the Financial Services Authority, published last week, proposed that banks should make ‘rainy day’ provisions in the good times to protect themselves against future economic shocks.

This ‘economic cycle reserve’ could be included in either a bank’s balance sheet or as a charge in a bank’s profit and loss account, he said, adding that there were ‘strong arguments’ for the latter option.

Senior figures in the profession have expressed support for the idea of a reserve, but have warned that requiring banks to include the provision into their P&L accounts would create new financial problems.

John Hitchins, PricewaterhouseCoopers’ UK banking leader, said putting the reserve on the P&L account would require a ‘fundamental change’ to international financial reporting standards, which currently only require companies to disclose incurred losses.

A consortium comprising the Financial Reporting Council, investors and top firms has warned that including reserve provisions within profit and loss would cause banks’ reported profits to dip.

This could confuse investors and generate negative headlines, said the consortium. It called for banks to ‘ringfence’ their reserves and disclose them in their balance sheets, next to items such as share capital.

Bank auditors can expect closer supervision after the Turner report signalled a ‘major shift’ in the way in which the FSA will monitor issues including calculation of the economic reserve cycle, the valuation of assets using ‘fair value’ and loan impairment provisions.

In the future the FSA will have ‘far more intense contact’ with bank management and auditors on these issues, Turner said Jonathan Hayward, chief executive of corporate governance adviser Independent Audit, said: ‘Auditors will have to defend their asset valuations and defend them in comparison with other banks. They may be challenged on valuations which seem out of line.’