HBOS Reporting failures go unchallenged

CormacButler 141HBOS – Reporting failures go unchallenged by Cormac Butler

The Financial Reporting Council (FRC) regularly appears in reports investigating what caused the banking crisis that engulfed UK and Irish banks in 2008. What has emerged from the HBOS report is that banks, along with the blessing of auditors like KPMG, appears to have deliberately overvalued and delayed the recognition of losses on troubled loans. This not only allowed the banks to sidestep regulation but also encouraged reckless lending. Bankers’ profits and bonuses went up based on the volume of lending even though the quality of such lending was questionable.

If bankers and auditors were aware of the damage they were doing, why they are not held to account?

The answer is that the FRC claims, probably incorrectly, that there is nothing illegal about hiding losses. In relation to KPMG's audit of HBOS for instance the FRC said that 'the criteria for commencing an investigation were not met'. The International Accounting Standards Board (IASB) has given two different versions of its rules for loan losses which it wrote for the European Union in 2004.

1. Under version one the IASB has said that banks must recognise all losses immediately "No entity is ever allowed to disclose assets valued at more than their recoverable amount in its financial statements".

2. However another IASB committee member has said of the same rules that applied in 2008 "Currently most standards on accounting for loan losses, including those published by the IASB, only require (and in fact only allow) provisions for these losses to be recognised when there is evidence that a loss event has occurred. In practice this has often meant that loan losses are only accounted for once borrowers default. And even then, the amount of losses that can be booked is restricted to reflecting the current situation."

These are two very opposing positions. Clearly only one is legal. KPMG has argued that it is required to delay telling shareholders about losses and the FRC has supported KPMGs’ view (version two). It follows that the FRC does not have grounds for investigating KPMG.

We understand that the FRC has obtained a legal opinion resulting in the view that the IASB rules are in accordance with company law and therefore legal. However, it is not clear to which version this opinion applies. If it is version one, then it appears to us that both KPMG and the FRC are encouraging bankers to flout the law. If it is version two then the former head of the IASB Sir David Tweedie may have misled the markets in 2008 when he reassured investors that banks following the IASB rules were required to recognise all losses immediately.