Treasury committee calls for reform of audit process

Auditors are not to blame for the banking crisis – but suffer from 'tunnel vision' when signing off accounts, according to a Treasury committee report which calls for an overhaul of the audit process.

In its final report into the crisis, the committee of MPs gave mixed assessment of the work of auditors, with the Big Four firms escaping the scathing criticism directed at bankers and other key City players in earlier reports.

But the report concluded that the audit process failed to highlight developing problems in the banking sector – which began with the run on Northern Rock in August 2007 and has seen a series of banks taken over by the state.

The report has also questioned how useful the audit process is currently and said trust in audit would be enhanced by a prohibition on firms conducting non–audit work for the same company.

'Our report does not conclude that auditors failed in their duties,' said committee chairman John McFall. 'However, the banking crisis has raised some serious questions about the usefulness of financial audit, and we have put forward suggestions for change.

The committee said that the banking crisis has exposed flaws in the audit procedure.

'The fact that the audit process failed to highlight developing problems in the banking sector does cause us to question exactly how useful audit currently is,' the MPs said. 'We are perturbed that the process results in "tunnel vision ", where the big picture that shareholders want to see is lost in a sea of detail and regulatory disclosures.'

MPs also raised concerns about the independence of auditors, a thorny issue the profession claimed to have addressed earlier this decade after the Enron corporate scandal caused the collapse of Arthur Andersen.

'We believe that, as economic agents, audit firms will face strong incentives to temper critical opinions of accounts prepared by executive boa rds, if there is a perceived risk that non-audit work could be jeopardised.

'We strongly believe that investor confidence, and trust in audit would be enhanced by a prohibition on audit firms conducting non-audit work for the same company, and recommend that the Financial Reporting Council consult on this proposal at the earliest opportunity.'

However, the committee rejected suggestions that auditors should provide a more extensive assessment of risks facing banks.

MPs backed suggestions by the Institute of Chartered Accounants in England and Wales to strengthen the role of bank auditors, including extending the audit to include an opinion on banks' 'regulatory capital rations' and for auditors and City watchdog, Financial Services Authority, to meet more frequently.

The FSA’s 'piecemeal approach' to using auditor knowledge about individual banks was a 'wasted opportunity' to improve the effectiveness of bank supervision, the committee said, and urged the FSA to respond to the ICAEW proposals.

Michael Izza, chief executive of the ICAEW, welcomed the committee's recommendation that auditors and regulators should work more closely. But he called for clarification on whether tax would be defined as a 'non audit' service which auditors could not provide to the same audit client.

He said 'If you try and concertina the auditor into a very narrow role in this country there is a risk that the profession will end up not being highly regarded and auditors will tend to end up being emasculated.'

The committee backed 'fair value' accounting rules, which critics have blamed for exacerbating the multi-billion losses in the banking industry by requiring banks to value assets at current market value.

'Fair value accounting has led to banks publishing some very dispiriting financial results, but this is because the news itself has been bad, not the way in which it has been presented,' the committee said.

MPs added: 'The uncomfortable truth for banks is that market participants had over-inflated asset prices which have subsequently corrected dramatically. Fair value accounting has actually exposed this correction, and done so more quickly than an alternative method would have done.'

'We do not consider fair value accounting to be a suitable scapegoat for the hubris, poor risk controls and bad decisions of the banking sector.'