Accounts from 2008 like works of fiction

Borrowing in the years up to 2008 by Anglo Irish Bank, Irish Nationwide, AIB, Bank of Ireland, Irish Life and the EBS so they could lend money into the economy was so out of control that it destroyed the institutions themselves and all but wrecked an economy on which 4.5 million people depended.

Yet the audited results for those institutions during those years showed healthy profits, and their senior executives took home pay packets based on those figures.

But if our financial institutions’ accounts from the “good years” have, with hindsight, taken on an element of black comedy, then, as yesterday’s report from the Chartered Accountants Regulatory Board (Carb) shows, this applies to the bad years too.

The report focuses on the quality of the audits of the 2008 accounts of the covered institutions and highlights how an earlier international effort to improve the financial reports produced by banks contributed to the production of accounts that could be regarded as works of fiction.

Property market

Audits are produced in the months after year’s end and the people from KPMG, PwC and EY who were working on the banks’ 2008 accounts were doing so in a world where the Irish property market was collapsing and it was not at all clear when the fall would stop.

Yet International Accounting Standard 39, which was introduced in 2005, stipulated that bank loans could only be classified as impaired after the impairment had in fact occurred. The rule prohibited provisions for impairments expected to occur in the future, no matter how likely they were.

So a bank that had funded a property project in 2006, with repayments due to begin in, say, 2010, had to classify it as a good loan in 2008, even though the workers on the site had been sent home and what little work had been done was already covered by weeds.

The rule was introduced to stop banks “smoothing out” their profit figures over years of varying performance by managing their estimates of likely loan losses.

The rule explains how Anglo’s 2008 accounts showed impairment provisions equal to 0.45 per cent of all loans, while AIB’s equivalent was 0.58 per cent.

The Carb report supports the accountancy world’s post-bust drift back towards the former “expected loss” model for financial institutions’s accounts, but it also wants to give greater scope for auditors to “override” the rules and rely more on “principles” as against just on rules.

Irony

There is, of course, an irony in this, given the world of financial regulation was prompted to recoil from its “principles-based” regimen when the banks began to collapse.

Auditors and regulators, and some bankers too no doubt, will continue to struggle with how to control the strange beast that modern finance has become. But it is worth remembering that even the best audits in the world in 2008 would have had little effect on the bad banking – and misleading accounts – that had been produced in the years before.