Banks caught in accounting limbo

Bank of England executives are worried that confusion over the way banks account for the value of their assets is damaging the economy. There are also concerns that international efforts to rectify the situation are stalling.

Under current accounting standards, banks use market prices to value loans in their accounts.

Losses are only realised if a bank sells assets. Reluctance to take such hits means the balance sheets of most banks remain bloated.

Former Chancellor Lord Lawson wants the Parliamentary inquiry into the banks to investigate the situation, considering it could be curtailing bank lending.

At the end of last year, Barclays said the fair value of its loan assets was £14.9bn lower than their balance sheet value. Lloyds Banking Group puts the potential hit at £17.3bn.

Market participants say the disposal of loans by banks has been far slower than expected. Tim Bush, head of governance at research firm Pirc, said mark-to-market accounting was “harming the real economy”. He added: “Zombie banks overvaluing loans are hence not being able to attract new private sector capital for new lending.”

The International Accounting Standards Board intends to introduce an “expected loss model” leading to a forward-looking approach to accounting for credit losses. Its move has been supported by several banks, including Barclays.

Last year, UK Business Secretary Vince Cable told Parliament the IASB was planning to introduce the rule in July 2011. However, the date was missed because the IASB got bogged down in talks with the US Financial Accounting Standards Board which has backed away from co-operation. An IASB spokesman said it hoped to introduce a standard in the fourth quarter.

Roger Marshall, chairman of the UK Accounting Standards Board, said time was needed to get the new rule right. But he conceded the European Union was unlikely to approve it until 2015.

Bush said: “The continual hiccups of the standard setters suggest that the accounting won’t be clean until at least 2015. That is untenable, Parliament should intervene.”

Last week, Andrew Haldane, the executive director for financial stability at the Bank of England, wrote in the Financial Times: “Global accounting rules have contributed to an overvaluation of legacy assets, as they prevent banks adequately provisioning. International efforts to rectify this are at risk of stalling.”

Bank of England Governor Sir Mervyn King is said to be sympathetic. He has told the House of Lords: “The fact the accounting convention says you don’t have to recognise a loss until the lack of payment has occurred doesn’t seem to me a very sensible or prudent basis to make business decisions.”

Lawson believes directors should be required to exercise prudence, adding that the parliamentary commission chaired by Andrew Tyrie should investigate. Lawson said: “I should be very surprised if the parliamentary banking commission does not look into this and ask Andy Haldane to give evidence.” Tyrie did not return calls requesting comment.