Is it time to overhaul the auditing of banks?


‘Dodgy auditing.’ That was the phrase used by MP Michael Meacher last week in
his scathing attack in the House of Commons on the advisers who aided the banks
being rescued by the government’s bail out package.

But Meacher wasn’t just slinging mud. He wants a full scale inquiry into the
conduct of the audit work that signed off the banks’ accounts. The former Labour
environment minister has put a letter to Gordon Brown on his website insisting
that no regulator has demanded transparency and ‘no auditor had condemned the
securitisation process on the grounds that it confounded the valuation of risk’.

He goes on to call for a Committee of Inquiry into the ‘governance,
accounting and auditing of the banks’. And suggests they should look at
‘offshore structures, complex derivatives and the lack of accounting

In addition, MP Harry Cohen tabled an early day motion demanding banks
‘comply’ with ‘higher standards’ of accounting.

Add to that the welter of demands on blogs and in national daily newspapers
where the role of auditors in the banking crisis appears to have caused
consternation, if not an entirely clear idea of exactly what they believe went

As vague or amorphous as those demands are, they add up to two things. First
an assumption that something’s gone wrong so auditors should have spotted the
problems. Second, mounting political pressure for something to be done. The
question is, will it happen? And what’s at stake?

So far, there appear to be no orders from on high, such as the Prime
Minister’s office, demanding a look at the role of auditors and their work.
Insiders at the Financial
Reporting Council
say the body is in daily contact with government and the
Financial Services Authority and there has been no indication that banking audit
needs an overhaul.

Within some of the professional bodies insiders say there is a view develo
ping that, though no one in power has given a green light to an audit review ‘it
is a legitimate question to ask’, even if you believe that ‘bank audits are not
the culprit’.

There are mitigating factors against a fresh look at bank audit in any case.
It was only in January last year that the
Auditing Practices
published a Practice Note for auditors. This ran to more than 100
pages and though not laying down rules for bank audit, the APB clearly hoped it
would be ‘persuasive’ and viewed as fairly comprehensive.

The sheer scale of the financial crisis and its consequences may be enough to
convince many that the report is now not enough.

But where would a review begin? Could it start with fair value measurement
and valuations, given that it has become such a controversial issue?

The 2007 report covers this and offers many points of advice, including the
auditor using his own valuation techniques to ‘test’ a bank’s valuations of
financial instruments ­ especially of things like derivatives.

But this is something David Gershon, chairman and chief executive of
consultancy SuperDerivatives that advises, among others, auditors, points to:
‘The possibility of an auditor producing a valuation that is even close is

His point being that there are brokers between traders in derivatives and the
auditors are not talking to them ­ therefore they cannot gain an accurate price.
He says auditors cannot rely on simply examining the process for valuation, they
would have to run a valuation themselves to stress test the process.

Senior auditors were quick, however, to kick those thoughts into the
distance. Auditors of banks recruit highly skilled individuals to undertake this

There’s a clear sense of grievance among auditors about being the easy
targets in the banking crisis.

It is interesting to read again the report produced by Swiss bank UBS, for
its shareholders after it wrote down $18bn of investments. The report reads like
a grim confessional but the bank is clear on the fact that it was its own risk
controls that lay at the heart of its problems. It points no fingers at external

Auditors here believe that the information was available if people chose to
read the financial statements, to see that statements of liquidity and
liabilities were being made. ‘The red and amber flags were there,’ said Martyn
Jones, national audit technical partner at

Jones believes auditors have been quite diligent in enforcing IFRS7, on
disclosing risk controls and mark to market accounting. A principle now
‘inappropriately’ under attack for apparently increasing transparency.

But where a serious question could be asked is in the area of the now defunct
Section 39 rules that required auditors to submit reports on internal controls
to the regulators. These were removed in a rush to cut regulation.

Returning measures such as these, Jones suggests, is a key debate that is yet
to be had.

The chairman of the
Financial Services
, regulator to the banks, said at the end of last week that a
fundamental debate was needed on the regulation of banks. If that happens it may
yet involve some change to their audits.

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