The Turner Review (a regulatory response to the global banking crisis) was published today along with a supporting 219 page discussion paper. The Review is a thoughtful paper which rightly aims to address the systemic challenges, the paper and its proposals deserve careful attention.
One novel proposal is of particular interest to accountants. He says that the present accounting philosophy where assets and liabilities are valued to reflect the facts of the situation at the balance sheet date in sensible from the point of view of shareholders in stable conditions. But he argues there are also dangers: in good times it means that bank capital will increase allowing more rapid growth and that the impact on share prices and perhaps bonuses can make further growth seem desirable. He suggests therefore that this philosophy may not be optimal from a regulatory, systemic and macro-prudential point of view.
He says it can fuel procyclicality and reiterates the point made by Avinash Persaud in ‘Regulation, valuation and systemic liquidity’ that if all market participants behave as one and attempt to liquidate their positions simultaneously, markets which were previously liquid will become illiquid and that realisable values will be significantly lower than previously suggested.
The IMF has also just published a paper called 'Procyclicality and Fair Value Accounting'. The paper finds that, while weaknesses in the FVA methodology may introduce unintended procyclicality and concludes that capital buffers, forward-looking provisioning, and more refined disclosures can mitigate the procyclicality. It suggests that valuation approaches for accounting, prudential measures, and risk management need to be reconciled and will require adjustments on the part of all parties.
Lord Turner’s proposed solution is for the P&L account to include an Economic Cycle Reserve which would set aside profit in good years to anticipate losses likely to arise in future. He presumably envisages that bonuses and share prices would reflect reported profits after such smoothing by the Reserve.
It will be interesting to see what people make of the proposal. Clearly we need accounts to contribute more to financial stability so the idea seems well worth constructive debate. ACCA has welcomed this by saying:
“It is essential that published accounts help contribute to financial stability. Lord Turner’s analysis of the challenge posed by the need for accounts, which are both meaningful at an individual level and at a macro level, appears to be sound. His proposal for an Economic Cycle Reserve is both interesting and worthy of debate. ACCA will be pleased to help facilitate such debate.” [add link to our PR]
ACCA has also said that financial services reform must aim at the next crisis – not the last one and that banks’ current risk aversion owes much to the economic climate and is likely to prove temporary. This gives governments and regulators a short but important breathing space in which to introduce a sustainable and robust regulatory regime.
ACCA agrees with the International Monetary Fund’s (IMF) recent assessment of the regulatory causes of the market failure – which highlighted financial regulation which could not identify risk concentrations and flawed incentives; macroeconomic policies which did not take systemic risks in the financial system and the housing markets into account and a fragmented global surveillance system.
However we know that there are other factors, particularly failings in corporate governance, which have contributed to the current crisis. Our discussion paper Corporate Governance and the Credit Crunch sets out the problem and recently the OECD published a similar paper.
Dr Steve Priddy, ACCA’s Director of technical, policy and research suggests: “In future we need a system where sound regulation, supervision and good corporate governance reinforce each other. The UK and its citizens will benefit from a profitable and more stable financial services sector which supports long term economic well being for itself and its stakeholders. Whilst we prefer a market solution rather than a regulatory answer to the other contributory factors, ACCA urges regulators to consider the problem as a whole.”
He is right, we do need a system like this - let’s up hope we are well on the way. However, it is already clear that the route ahead is littered with obstacles.
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