Thursday, 31 July 2008

What does this mean?

The UK government has just published its views on financial stability and depositor protection. The document has this rather interesting paragraph (see para 2.67):

"The IASB (International Accounting Standards Board)has set up expert advisory panel to examine whether existing IASB requirements and guidance on the accounting and valuation of structured products could be improved. The advisory panel, which had its first meeting in early June, should draw upon the analysis undertaken by European banking and securities regulators. A specific area the Authorities call on the IASB to review is the current requirement that when any of an unrealised value loss on an available-for-sale security (broadly an investment security) is regarded as due to impairment, the entire loss has to be recognised immediately in the profit and loss statement. It is not clear this position is conceptually sound, and it creates an incentive for firms to delay timely recognition of impairment."
The government appears to be pushing the idea that the IASB should drop the requirement that any unrealized losses on marketable securities be recognized. This seems to be saying that banks can effectively conceal losses by recording the historical rather than market values, or have I missed something here.

Many thansk for McC, who sent me an email pointing this document out to me.


Josh said...


aSteve said...

The link to the document was "404" broken when I clicked...

Anyhow, this actually sounds fairly sensible. I think this relates to FASB-157 which, in the USA, says "mark to market, do it NOW!" - which might not be possible for most banks if they are to remain solvent. If a bank were to be able to accept that market values of its assets had fallen, but to then write this off at an agreed rate every month, the re-capitalisation could be gradual and from profits. Of course, this would render the business dramatically less valuable... but that's the way the cookie crumbles.

It doesn't seem all that unreasonable either... to me, at least.

Alice Cook said...

Link fixed.....

Alice Cook said...


Don't you see any potential for abuse.

For example, would the Bear Stearns SIVs have collapsed if they had this kind of accounting?


aSteve said...

Of course there's room for abuse... but that's not the point. Think of the alternatives:

Mass government bale-out (definitely room for abuse there)

Continuing to play hide-and-seek with the losses (like Barclays - room for abuse there too)

Posting entirely fictional accounts - like BCCI (to encourage this would be irresponsible.)

Essentially, the banks can't be allowed to fail - and the extent to which they can generate huge bonuses is regulated by the FSA. I see a situation where the losses can be made public ASAP - even if they're phased into the accounts - would be a big improvement over having to pretend that the losses have not been sustained.

With banks, it all comes down to regulation. The FSA can be criminally negligent with or without this leeway - as they've adequately proven to date.

I think the key point is that banks and their shareholders must be held accountable for the losses in any way that works. If they were able to force the hand of the MPC into relaxing monetary policy, that would be a far worse outcome.

Nick Drew said...
This comment has been removed by the author.
Nick Drew said...

Alice, on this one I'm broadly with asteve. They don't need any encouragement to hide stuff, so they may as well be teased out gently into the open.

Not an accountant (but I do know about structured products). I assume, somewhat similarly to asteve, that the alternatives being considered are (a) recognise the impairment AND MAKE A PROVISION vs (b) realise the impairment straight away (in P&L).

What's often happened amongst non-banks is that big out-of-the-money positions have carefully NOT been marked-to-market (often requring some pretty dubious accounting rulings - by compliant auditors, we all know the story) and a 'convenient moment' chosen to take the hit. That has often been several years after the impairment was first obvious - I could name names. (BTW, some do it right, e.g. the exemplary conduct by Mitchells & Butlers after their big screw-up last year.)

Banks are more closely scrutinised (a bit ...) but they've often got even more incentive to be chary of recognising a hit, because if they write down one asset in a class, they must then do the same for the rest. Example: the UK electricity generating sector 2002-3 (when BE went under) and the banks were left holding the keys of many power stations (though not BE's, of course). But they tacitly conspired not to write down these assets, for fear of the chain reaction - and they held their collective breath until power prices rose once more.

I assume the 'authorities' would like a little more clarity without explicitly requiring mass suicide. It may be in all our interests that they succeed, even if a stricter regime could be argued for.

Anonymous said...


I am an accountant, though I work as an auditor now. It's all very simple. FASB-157 is a good idea because accounts have to be true and fair, and booking assets at their correct value is necessary to give shareholders and accurate picture of the company (which is the point of accounts - to bridge the agency-principal problem).

Accounting principles are towards prudence. That means a revaluation upwards is recorded as an unrealised gain (if at all) and an impairment hits the P&L. Really the question about FASB-157 is whether it should've been allowed on the way UP, not the current whining about on the way DOWN.

The whining now is simply the banks want mark to market in the good times and not the bad. That's in flagrant violation of the principles of accounting. The question now addressed is also very simple:

Do banks have an obligation to produce accounts that are true and fair?

In case you missed the memo, we entered a period of regulatory forebearance in October 2007 where the answer is "No, just do whatever it takes to survive".

My own opinion is the banks should record their assets and liabilities at fair value and let the chips fall where they may. Not only is this the morally and professionally correct way, but it's also the only way to get out of the credit crunch. The alternative is Japan's lost decade.


Alice Cook said...

Nick comes to the rescue, yes, yes yes, I wish I could add your comments to my post. You obviously understand this issue better than I do.


Anonymous said...

Thanks Alice. BTW, within three hours of typing this I check the internet and lo-and-behold the FASB has thrown in the towel.

Looks like regulatory forebearance is extended a little further


Anonymous said...


Just thought I'd clear this up from an accounting perspective by giving the accounting entries of your two scenarios(perhaps someone who actually does financial accounting in a bank could give the detail).

(a) recognise the impairment AND MAKE A PROVISION

Dr Profit & Loss a/c
Cr Bad Debt Provision (balance sheet)

(b) realise the impairment straight away (in P&L).

Dr Profit & Loss a/c
Cr Debtors

The only difference is whether you reduce the value of the asset on the balance sheet by reducing it's carrying value directly, or by keeping it booked at the original value but putting an offsetting credit right underneath it. Either way you have to debit the P&L.

The sneaky way is to take it straight out of reserves without going through the P&L. It still reduces shareholders funds (i.e. the value of the company) but it doesn't reduce earnings for the year.


Nick Drew said...

Thanks, Nick

told you I wasn't the accountant! (but I do know some of the Ways of the World ...)