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July 26, 2009

ICAEW defends IFRS following EC criticism

The Institute of Chartered Accountants in England and Wales (ICAEW) has argued against European allegations that accounting standards have been an important factor in amplifying the financial crisis.

A new report from the European Commission Council on Economic and Financial Affairs (ECOFIN) on reducing pro-cyclicality in the financial sector alleged that two important factors in the amplification of the financial crisis have been the absence of counter-cyclical buffers and the lack of flexibility of accounting rules in allowing through-the-cycle provisioning.

It stressed the urgency and importance of addressing these issues.

Suggestions included introducing forward looking provisioning, which consists of constituting provisions deducted from profits in good times for expected losses on loan portfolios.

IFRS do not currently allow for the recognition of expected losses, although the International Accounting Standards Board will publish an exposure draft dealing with the provisioning issue, including consideration of an expected loss model, by October this year.

The ECOFIN report suggested the standard setter should give priority to amending the current accounting rules to allow for more flexibility for provisioning expected losses.

But Iain Coke, head of the ICAEW financial services faculty, said that if policymakers want to increase capital buffers in banks, they should concentrate on getting the prudential capital rules right, rather than tampering with financial reporting.

“There is at present no credible evidence to support the view that the accounting rules contributed to the financial crisis. If such evidence exists, we have yet to see it,” Coke said. “We strongly reject the assertion that counter-cyclical accounting buffers would improve financial reporting or how financial reports are used.

“The insurance industry has experience of through-the-cycle provisioning with so-called ‘equalisation reserves’. These reserves were dismissed by many users as meaningless information in financial statements that simply obscured the true financial position.

“Changing the accounting rules will not achieve any regulatory objectives that cannot be achieved through other, more direct means, such as the prudential capital rules.”

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