Chairman of the US accounting standard setter has slammed banks for 'stretching' accounting rules so as to manage their risky assets.

Robert Herz, chairman of the Financial Accounting Standards Board said that the current accounting rules governing the treatment of risky assets on the books of lenders are 'a fantasy' and need to be redone.

'It [the rules] didn't work, it was stretched, and not complied with,' Herz told delegates at a regulation summit in Washington.

He was referring to FAS 140, which decides whether a bank can treat assets held in various securities as sales or secured financing and when these can be left off the balance sheet.

'The original rules made sense, it's just the market practice didn't comply with that,' Herz said.

Herz's comments follow growing criticism of an exemption this month granted to lenders by the chief accountant of the Securities and Exchange Commission, Conrad Hewitt.

Hewitt allowed an exemption from rule FAS 140 which would allow lenders to keep problematic sub-prime debt off their balance sheets.

Under the rules, complex structures and accounting methods were applied so as to allow mortgage-backed securities and other asset-backed structures to be labelled 'qualifying special purpose entities' or QSPEs, Reuters.com reported.

The special entities were considered to be out of the control of the lenders and therefore qualified to be off their balance sheets.

'Things were written into the agreements and in some cases the auditors didn't see them and even the companies didn't see that they violated these rules,' Herz said.

The FASB plans to re-write the complex rule to prevent further manipulation of the balance sheet.

'People like... to do business off balance sheet, and we like transparent accounting and those things tend to clash,' Herz said.

FRC chief executive Paul Boyle said he was unlikely to grant any exemptions to UK lenders.

'If there are genuine economic risks that business would be exposed to, those facts need to be reflected in the financial statements, even if results are somewhat unattractive,' he said.

Boyle's comments come ahead of reporting season which kicks of next week with reporting by Bradford & Bingley.

Further reading:

FASB says no to accounting relief for questionable mortgages