Bank profits distorted by audit rules, warn investors

In a letter to Business Secretary Vince Cable, the investment houses, which include Threadneedle Investments, the Co-Operative Asset Management, London Pension Fund Authority and Railpen, said accounting rules are “harming” shareholders and destabilising banks and the economy.

The hard-hitting letter, signed by nine investor groups and seen by The Daily Telegraph, states: “We believe that… 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.”

They claim the views expressed in the letter, sent to Mr Cable last week, are backed by a “coalition of 27 signatories representing approximately £1.34 trillion in assets… and several individual investor associations from around the EU.”

The investors’ complaints centre on the controversial International Financial Reporting Standards (IFRS), which Britain adopted in 2005, reports The Telegraph .

While Britain’s Accounting Standards Board (ASB) and the London-based International Accounting Standards Board (IASB) have insisted the adopted rules are an improvement, experts have claimed they allow banks to hide risks and boost profits and bonuses. Calling for a meeting with Mr Cable, the investors claim the “negative impacts” are most dangerously seen in British banks where “IFRS currently prevents banks from making prudent provisions for expected loans losses.”

By hiding poor loans, profits can be boosted, in turn allowing banks to pay out bigger salaries and bonuses.

The letter says: “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 letter continues: “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.”

The letter echoes warnings raised by Tim Bush, the City veteran , that the accounting rules amounted to a “regulatory fiasco”.

An investigation by the House of Lords Economic Affairs Committee agreed that there were “very serious problems” with the rules.

Last year’s Future of Banking Commission concluded the rules were an “important factor in allowing the behaviour that lead to the banking crisis”.

Andy Haldane, head of financial stability at the Bank of England, has recently called for banks to have their own accounting system – and one he has warned will force banks to raise billions of pounds of capital.

Investors have said they have already raised concerns with Lord MacGregor, chairman of the House of Lords Economic Affairs Committee. They have also called for action from the EU Commissioner, Michel Barnier.