Debates about financial reporting and accounting standards can seem arcane, tedious and irrelevant: angels dancing on the heads of pins stuff. However the current debate about whether international financial reporting standards (IFRS) drove banker recklessness is getting interesting.
A former fund manager at Hermes, Tim Bush, who is also a member of the urgent issues taskforce of the UK's Accounting Standards Board, set the cat among the pigeons with claims that IFRS as applied in the UK and Ireland had catastrophic side-effects.
Responding to the ASB’s consultation on accounting standards, Bush said that IFRS, as applied by the ASB since 2005, seriously exacerbated the financial crisis. He said it did this by enabling banks to live in a fool's paradise in which their boards were unable to get a firm handle on vital measures like capital and profit.
Basically, says Bush, IFRS caused banks to think they were profitable and well-capitalized when in fact they were loss-making and devouring capital. In a 24-page letter, written on August 19 and sent to the Bank for International Settlements as well as to the ASB and other accounting bodies, Bush said IFRS, as applied in the UK and Ireland,
“produces false profits, overstates capital, misleads creditors, misleads shareholders, the Bank of England, FSA and others … IFRS has been a deadly dose, by removing what had underpinned banking solvency for over 120 years…
“In engineering terms it was like a signalman sending a train down the wrong track. The UK had the first failing bank, Northern Rock, which only the month earlier appeared to have so much capital it applied to reduce it."
His letter came in response to the second stage of the consultation on the future of UK and Irish accounting standards being carried out by the ASB. Implicit within this consultation is the notion that UK accounting standards should be fully replaced by IFRS, even for small and medium-sized enterprises.
However Bush is urging caution given that IFRS "gave false assurance in the absence of correcting standards. The impact of this has been different and far more dangerous in the UK and Ireland given the extent to which IFRS was rolled out more fully in these states than other parts of the EU.” He added that:
"[Banks'] accounts were unreliable for capitalism to function properly as they did not show the capital..."
Bush traced the problem to the fact the ASB was asked to set accounting standards for the purpose of the Companies Act (which includes supporting banking solvency) whent it should have merely focused on “financial reporting standards” for the purpose of the EU Capital Market Transparency Directive.
According to Bush, this was a fatal error. He blames the Westminster parliament for failing to change "the required output standard of audited accounts of banks (i.e. repealing Sections 830-837 of the Companies Act)..."
Bush contends that, in cloaking themselves in IFRS, UK bank directors were forced to commit illegal acts. He said following IFRS, as applied in the UK, was:
“positively contrary to the objective of directors discharging their duties properly. False profits, hidden losses and hidden gearing (note: hidden losses are also hidden gearing as capital is overstated) are possible with IFRS.”
Bush accused the ASB of being an accessory to these alleged crimes since “applying some IASB/ASB standards positively breaks the objective of the law, and basic business economics ... The system misleads itself creating an aberration of governance under the apparent best practice of it.”
Bush, whose views also featured in an article in the Daily Telegraph, is concerned that, even two years on from the crisis, the system remains as deeply flawed as ever, and still enables UK and Irish banks to deceive themselves and all their stakeholders about their true financial positions. He strongly urged the government to scrap plans to extend IFRS in the UK.
Richard Murphy, founder of Tax Justice UK, and director of Tax Research, concurred with Bush's views. Writing in his blog, he said:
"If Tim is right – and I think he is – the case against bank auditors is compelling, and cannot be avoided by claiming they relied on IFRS alone. UK company law has priority – and I think they ignored it."
My fear is that Bush will be dismissed as a maverick and that this will fall on deaf ears at the Accounting Standards Boards, ICAEW, ICAS and the other myriad of accountancy bodies in the UK. But that would be real folly, though, wouldn't it?
Further reading on IFRS analysis and the role of IFRS in the banking and financial crisis:
- Origins and Rationale for IFRS Convergence by Peter Walton
- Understanding the Requirements for Preparing IFRS Financial Statements, by Véronique Weets
- IASB grapples with weapons of mass destruction by Anthony Harrington [blog]
Tags: accounting standards , banking , fair-value accounting , IFRS , international accounting standards , Ireland , UK