Flawed Rules Added to Bank Losses in Crisis, Pension Group Says

Flawed accounting rules stopped U.K. and Irish banks from booking potential bad loans and led to a “misdiagnosis” of the 2008 banking crisis, contributing to the loss of 150 billion pounds ($236 billion) of capital, according to a pension fund lobby group.

The IAS 39 International Financial Reporting Standards rule prevents banks from using their own data to anticipate future losses from loans before they occur, said the report by the Local Authority Pension Fund Forum. That meant loan books looked more appealing than they actually were and banks appeared to have sufficient capital, said the report.

“Banks that appeared to be solvent within a few months required an enormous amount of taxpayer support in order to survive,” said the LAPFF. “The failure to identify accounting standard setting as a root cause of the initial phase of the banking crisis led to a misdiagnosis of the problem as one of liquidity rather than solvency.”

British banks were propped up by about 1 trillion pounds in capital and guarantees after Lehman Brothers Holdings Inc. collapsed in 2008. Two of Britain’s largest banks, Royal Bank of Scotland Group Plc (RBS) and Lloyds Banking Group Plc (LLOY) ceded stakes to the government, while Northern Rock Plc was seized by the state.

Bank of England Governor Mervyn King said in June’s Financial Stability Report that the IAS 39 rule “represents a change from the accounting regime that U.K. banks followed at the time of previous recessions, which was generally viewed as less restrictive on the level of provisions allowed.”

New rules are being discussed by IFRS to allow a more forward-looking approach which could allow quicker writedowns, the BOE said.

Illiquid Assets

U.K. and Irish banks lost more than 150 billion pounds of capital during the crisis, the report estimates, using amounts stated in 2007 accounts. Other problems during the crisis posed by the rules related to the classification of equity and the mark-to-market pricing of illiquid assets, the report said. The actual sale of such assets would cut the price, the study said.

“Significant reform of both accounting standards and the standard setters is required,” the forum’s chairman, Ian Greenwood, said in the report. The LAPFF represents 54 U.K. pension funds with combined assets of more than 100 billion pounds.

The report was written by Tim Bush, head of governance and financial analysis at Pensions & Investment Research Consultants Ltd., an investment adviser and research unit of the LAPFF.

To contact the reporter on this story: Howard Mustoe in London at hmustoe@bloomberg.net.

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net

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