The head of the City's financial watchdog has blamed accounting rules for inflating banking bonuses in the lead up to the global financial crisis.

Adair Turner, chairman of the Financial Services Authority, told Accountancy Age the pro-cyclical effect of fair value pushed asset prices to artificial highs, which fed into profit estimates and rewarded bankers with inflated bonuses.

“Fair value accounting on the way up can produce a self reinforcing cycle,” he said.

“The price of credit security had gone up - everything was looking more favourable. Banks were making more profits, but they were unrealised fair value profits.”

Fair value, the accounting principle set by the International Accounting Standards Board, has been blamed for exacerbating the effects of the downturn.

The rule required banks to value their financial assets at market price, which led banks to dock huge losses as liquidity plummeted following the banking crisis.

Lord Turner said the high bonus culture could be fought on two fronts: “You can address that on the accounting sides and or address it on the remuneration.”

“You simply don’t know at the end of the year whether that profit will really be there,” he said.

Further reading: FSA: Accounting must help avoid another bank crisis