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UK bank profits ‘distorted by accounting rules’

Your Money
Written By:
Your Money
Posted:
Updated:
19/11/2012

The UK’s accounting rules are distorting bank profits and leading to confusion over executive pay, some of the country’s largest investors have have warned.

In a letter to business secretary Vince Cable last week, seen by the Daily Telegraph, major investment houses including Threadneedle, and the Co-Operative Asset Management, said the rules are “harming” shareholders and destabilising banks and the economy.

According to the Telegraph, the letter was signed by nine investor groups and called for an overhaul of accounting rules.

It said: “The accounting and auditing systems in the UK are harming long-term shareholders by undermining our ability to reliably assess capital held by companies (especially banks); clouding our understanding of executives performance (and the relating problem of assessing remuneration); and by contributing to macroeconomic instability.”

The investors’ complaints centre on the International Financial Reporting Standards (IFRS) Britain adopted in 2005. Experts have claimed they allow banks to hide risks and boost profits and bonuses.

“IFRS currently prevents banks from making prudent provisions for expected loans losses,” the letter said. “We have too often found ourselves in a position where executives are remunerated on the basis of ‘paper profits’ that were not actually earned.

“The emphasis placed on mark-to-market valuations has, moreover, resulted in excessive volatility reflecting changing market sentiment, rather than economic fundamentals. The volatility clouds our view of performance and makes it difficult for us to determine reliably a company’s capital position.”

Meanwhile, the Association of British Insurers (ABI) has warned UK banks are at risk of becoming uninvestable, according to the Telegraph. The body argued institutions are reluctant to invest in high street banks because of increasing risks and shrinking returns.

The ABI is preparing to deliver a report to the Parliamentary Commission on Banking Standards on behalf of its members, who are among the bank’s biggest investors.

In preliminary evidence last week, the ABI told the Commission: “We are concerned that banking regulators are currently focused on financial stability at the expense of economic growth. This has a negative impact on banks’ investability.”

The ABI added: “The prospects of sustainable economic recovery in the UK are to some extent dependent on banks being able to raise the funds necessary to finance the growth of small and medium-sized companies. From the perspective of institutional investors, it is essential that banks should be an investable proposition.”