Speaking at a conference hosted by the ICAEW, Lord Turner argued that banks must be viewed differently from any other sector of the economy, including the rest of the financial sector. Accounting standards relevant to banks need to reflect these differences.
Financial Services Authority (FSA) Chairman, Lord Turner, today called for close engagement between global accounting standard-setters and those responsible for prudential regulation of the banking sector to address issues arising from the unique systemic nature of banks.
Speaking at a conference hosted by the Institute of Chartered Accountants of England and Wales (ICAEW) in London, Adair Turner said: “No other sector of the economy is remotely comparable to banking in its capacity to be a driver of economic volatility rather than a victim of it.” As a result, he argued that banks must be viewed differently from any other sector of the economy, including the rest of the financial sector, and that accounting standards relevant to banks need to reflect these differences.
He highlighted two aspects of existing bank accounting practice which contribute to the problem of procyclicality and are, therefore, intrinsically tied to macro-prudential and macro-economic concerns:
- First, the accounting treatment of loan losses within the banking book. This bases loan loss provisions on evidence of already current credit impairment and does not allow for reasonable judgements on future potential losses.
- And second, the ‘fair value’ valuation approach (predominantly ‘mark-to-market’) in the trading book, which recognises unrealised gains or losses and which, especially when applied to illiquid securities, can drive harmful volatility in both upswings and downswings.
In respect to the first, Adair Turner welcomed the increasing dialogue between the International Accounting Standards Board (IASB) and prudential regulators and highlighted, in particular, the IASB’s consultation on a new version of IAS39, which would require loans on balance sheet to bear an ‘economic loss’ provision, rather than recognising losses solely according to the existing incurred loss approach. Adair Turner commented: “In principle this approach has merit, but the devil is very much in the detail and, in particular, in the detail of how ‘economic loss’ will be calculated.”
If calculation of economic loss refers to current market expectations of future losses, there would be a danger of this becoming mark-to-market by another name, creating even greater procyclicality than in the past.
In respect to the trading book, Adair Turner recognised that there is no alternative to mark-to-market accounting for some instruments, that there is information which shareholders should logically value in mark-to-market accounts, and that there is a danger in allowing the freedom to switch accounting approaches to hide problems. Conversely, however, too widespread an application of mark-to-market accounting can exacerbate system volatility.
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