One of the least understood and most damaging aspects of the financial crisis is the way International Financial Reporting Standards (IFRS) mislead UK and Irish banks and their stakeholders about their true financial positions.
These accounting standards have contributed enormously to the severity of the financial crisis in both countries, and, until they are reformed, pose a lethal threat to any prospect of recovery.
Among other problems, IFRS accounting rules incentivise trading in derivatives by enabling unrealised, perhaps fake, profits to be booked up-front, leading to large but unjustified bonuses and dividends.They grossly inflate profits and capital and discourage banks from making prudent provision for expected loan losses.They also discard the time-honoured principle of prudence embodied in UK company law. In doing so, IFRS gravely weakens the audit function and the vital check it imposes on bank management. This undermines effective corporate governance in banking. The upshot is that IFRS makes bank accounts highly unreliable; no-one has a true view of our banks' financial strength. All this contributed greatly to the financial collapse. IFRS made banks appear more profitable than they were. This led them to imprudent expansion, to payments of bonuses they could ill afford to make and to inadequate provisioning for likely losses.
Like dishonest scales of Proverbs 11, IFRS fundamentally misled senior managements, investors and regulators. Yet IFRS abuses continue.
RBS's valuation of its own assets differs from that of the Government' Asset Protection Scheme, prepared on a more prudent basis, by as much as £25 billion. Barclays investors have asked the Financial Reporting Council to investigate whether their accounting treatment of bonuses under IFRS distorted profits. Banks may reply that accounts have been prepared on a different basis, but that's precisely the point. Others retort that it's all within the rules and everyone is doing it. Surely we have heard all that before?
It's vital that accounting standards be reformed to stamp out these practices, to eliminate the consequent injustices and put UK accounts back on a reliable basis. That's why I introduced a private member's bill to require parallel accounts in accordance with UK companies' law. Pressure is mounting on the Government to adopt it.
IFRS does not provide a sufficiently prudent view of banks' positions and, for that reason, it may not be legal. Now, as when Proverbs 11 was written, dishonest scales are wrecking business, the business of banking.
Steve Baker is the Conservative MP for Wycombe. He has a background in aerospace and software engineering, and a broad experience of banks and their regulators