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June 19, 2013

Auditors also to blame for banking scandals

In an excoriating report published today the UK Parliamentary Commission on Banking Standards (PCBS), set up by Chancellor George Osborne following a number of scandals involving the banking industry, has attacked bankers, regulators, investors and auditors.

While stating that "primary responsibility for banking standards failures must lie with those running the banks", regulators, and auditors all come in for criticism for failing to understand the risks building up in the banking system. "Many others, including accountancy firms and credit rating agencies and the Financial Services Authority (FSA) left the UK poorly protected from systemic risk," the report declares.

Pointing out that auditors and accounting standards have a duty to ensure the provision of accurate information to shareholders and others about companies’ financial positions, the report goes on to say they fell down in that duty. Auditors failed to act decisively and fully to expose risks being added to balance sheets throughout the period of highly leveraged banking expansion. And audited accounts conspicuously failed accurately to inform their users.

The Commission states that an enhanced auditor commentary would benefit investors and other users of financial statements. "We welcome the IAASB’s work to develop a model for best practice," it says. "However, we consider the subjective matters of valuation, risk and remuneration, amongst other key judgment areas, are so critical to investors’ understanding of a bank’s business model that an upfront, independent opinion would be beneficial. The Commission therefore recommends inclusion of specific commentary on these areas in auditors reports on banks’ accounts."

Despite general agreement that effective communication between auditors and supervisors is crucial, the report says in the past the relationship between supervisors and auditors has been dysfunctional. It recommends that the Court of the Bank of England commission a periodic report on the quality of the dialogue between auditors and supervisors. And, to be effective, both the PRA and the FCA will need to meet a bank’s external auditor regularly, and more than the minimum of once a year specified by the Code of Practice governing the relationship between the external auditor and the supervisor. This should be a legal requirement, as already recommended by the House of Lords Select Committee on Economic Affairs.

Representatives of the audit profession should also have the opportunity to discuss emergent issues arising from their work with the PRA, the FRC and HMRC. "We expect that this would require thematic meetings," says the report.

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KPMG UK’s head of financial services Bill Michael said in response to the report: "KPMG agrees with the report that there are lessons for all parties, including auditors, from the financial crisis. KPMG has been an active player in the debate about ways of making the audit more market-responsive and forward-looking.

"Dialogue and communication between auditors, regulators and banks is fundamental. This has already improved significantly. KPMG was actively involved in the development of the Code created by the FSA and Bank of England.

KPMG UK is so far the only Big Four firm to comment on the report.

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