The UK government has delayed implementing international financial reporting standards (IFRS) for the public sector for another year. In his 2008 budget the chancellor, Alistair Darling (pictured), recognised the scale of the challenge, particularly in relation to private finance initiative (PFI) accounting, and announced that government accounting policies will now require full implementation of IFRS for the year ending March 31,2010. This means that PFI will remain off balance sheet for a further year. [ILLUSTRATION OMITTED] Mark Williams, a member of Deloitte's government accounting advisory team, pointed out that the private sector had had five years to make the transition to IFRS. Although no firms missed that deadline, there were times when failure seemed possible, he said. "An incidental result of delaying IFRS is that the government won't need to bring what some commentators say could be up to 30bn [pounds sterling] of PFI spending on to its balance sheet for another year. Although it was never certain that this would become government debt, there are significant implications for the government's debt position and its ability to comply within its own fiscal rules," Williams said. "A year delay does not mean that public bodies can 'park' the issue. It is paramount that they keep up the momentum," he added. COPYRIGHT 2008 Chartered Institute of Management Accountants (CIMA) Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision. The purpose of Basel II, which was initially published in June 2004, is to create an international standard that banking regulators can use when creating regulations about how much capital banks need to put aside to guard against the types of financial and operational risks banks face. Advocates of Basel II believe that such an international standard can help protect the international financial system from the types of problems that might arise should a major bank or a series of banks collapse. In practice, Basel II attempts to accomplish this by setting up rigorous risk and capital management requirements designed to ensure that a bank holds capital reserves appropriate to the risk the bank exposes itself to through its lending and investment practices. Generally speaking, these rules mean that the greater risk to which the bank is exposed, the greater the amount of capital the bank needs to hold to safeguard its solvency and overall economic stability. The final version aims at: While the final accord has largely addressed the regulatory arbitrage issue, there are still areas where regulatory capital requirements will diverge from the economic. Basel II has largely left unchanged the question of how to actually define bank capital, which diverges from accounting equity in important respects. The Basel I definition, as modified up to the present, remains in place. Basel II Bank for International Settlements Banking Credit risk Basel II uses a "three pillars" concept – (1) minimum capital requirements (addressing risk), (2) supervisory review and (3) market discipline – to promote greater stability in the financial system. The Basel I accord dealt with only parts of each of these pillars. For example: with respect to the first Basel II pillar, only one risk, credit risk, was dealt with in a simple manner while market risk was an afterthought; operational risk was not dealt with at all. By general accord, much of the current financial crisis arises from "regulatory failure", something to which numerous references have been made, not least by the shadow chancellor over the weekend, when he complained that "Gordon Brown's regulatory mechanism has comprehensively failed". When the value of financial assets falls, a new international accounting regulation called "marking to market" automatically downgrades the value of banks. They are less able to raise the money to carry on their business. That in turn causes further falls in the value of financial assets. And this is making the financial crisis worse than in previous downturns.
Financial Management (UK), April, 2008
COPYRIGHT 2008 Gale, Cengage Learning
Basel Accord - Basel I
Basel IIBackground
Monetary policy - Central bank
Risk - Risk management
Regulatory capital
Tier 1 - Tier 2Pillar 1: Regulatory Capital
Standardized - F-IRB - A-IRB
PD - LGD - EAD
Operational risk
Basic - Standardized - AMA
Market risk
Duration - Value at riskPillar 2: Supervisory Review Pillar 3: Market Disclosure Business and Economics Portal The Accord in operation
A European Union directive passed in 2001 and adopted as a new accounting standard in the UK in 2006 dictates that banks have to value their assets on a daily basis. To do this they must base their calculations on the market value of each asset if it were liquidated that day. The problem with this is that as share values tumble in response to the credit crisis, millions of pounds are wiped off bank balance sheets causing a spiral of decline in asset values.
Actually, The Guardian has got it wrong. The "European Union Directive" in question is Directive 2006/49/EC of 14 June 2006 "on the capital adequacy of investment firms and credit institutions". Its short title is the Capital Adequacy Directive. This must be read in conjunction with Directive 2006/48/EC, the pair of Directives together implmenting the agreement.
That it is an EU directive, though, does not tell the whole story for it is this directive which implements crucial parts of the now notorious Basel II agreement. It is that agreement that which is the heart of the current problems which the banks are experiencing.
That Basel II is the problem – the "smoking gun", so to speak - has been widely promulgated for some time by acknowledged experts, most notablylast December by Prof. Peter Spencer, of the Ernst & Young Item Club, regarded as "one of Britain's leading economists". It was then that a report of his views said:…conflicts caused by the Basel system of banking regulations, which determine how much capital banks must to keep their books in order, are the root cause of the crunch and were serving to worsen the City's plight.
The regulations meant that banks forced to take off-balance sheet assets from troubled structured investment vehicles on to their books had little choice but either to raise money from abroad or cut back dramatically on their spending, he said.
He warned that, if London's money markets remained frozen and the authorities retain the strict Basel regulations, the full scale of the eventual credit crunch and economic slump could be "disastrous".
Dismissing the assumption that banks are not lending to each other on the money markets because they lack confidence in each others' potential solvency, he argued that they were, in practice, prevented from lending the cash at all because it could leave their balance sheets falling foul of the Basel regulations.
"If these funding routes are not reopened it will have massive consequences for the economy as a whole," he said. "It will make 1929 look like a walk in the park."
He dismissed as "window dressing" the move announced by central banks around the world this week to pump extra money into the money markets and increase the type of collateral they will accept in return, in an effort to get them running again.
"This won't get to the core of the problem: the fundamental lack of collateral. As these problems drag on, the consequences for the macro-economy of not relaxing [the Basel regulations] are unthinkable."
Not only do the regulations, which stipulate that banks must have a minimum of 8pc capital among their liabilities, deter banks from lending to each other, they will also limit the amount they can lend to households and businesses. This could escalate the anticipated economic downturn next year significantly, he said.The Spencer analysis was then essentially repeated at the end of January by another acknowledged expert, Prof. Tim Congdon.
In the context of the Northern Rock affair, Congdon asserted that, "the Basel rules have failed", then arguing that "the scientific precision of the Basel rules was shown to be hocus-pocus." Banks, he wrote:…did not know the true state of each other's capital and, hence, their ability to repay loans. Inter-bank markets seized up. If one bank - such as Northern Rock - ran out of cash, it had only one place to go, its central bank. But the assumption that the central bank would, quickly and reliably, extend a lender-of-last-resort loan to a solvent, but illiquid bank - an assumption written into banking textbooks for decades - was invalidated by the Bank of England's reluctance to lend in crisis circumstances last August.
So it was yesterday that Cameron stood up in front of the Conservative Party conference and declared that "…our regulatory authorities, together with the European regulators, need to address this difficult issue."
He did not name the Basel II agreement and, crucially, neither did he identify the more immediate cause of the problem, the EU Capital Adequacy Directive. Had he done so, of course, there would have been uproar, and the EU would have been catapulted to the top of the political agenda, which is the last thing Cameron would have wanted.
And it is the Directive which is now the problem. The reason for this is that, although the original Basel II agreement was produced in June 2004 with the assent of the British authorities – which had pushed hard to their adoption – the sponsoring organisation, the Basel Committee on Banking Supervisiondoes not produce legislation.
Instead, it "formulates broad supervisory standards and guidelines" and recommends statements of best practice in banking supervision "in the expectation that member authorities and other nations' authorities will take steps to implement them through their own national systems, whether in statutory form or otherwise."
Had the UK been an independent country in 2004 and subsequently, the government would have implemented the Basel II agreement into UK legislation, either through an Act of Parliament or through Regulations (SIs) – or a combination of both.
The trouble was that, not only was the UK a member of the European Union, financial services regulation was (and is) a "competence" of the EU and the UK had thereby ceded authority to legislate in this area. Thus, instead of being adopted into British law directly, it was adopted via an EU Directive.
That, at the time, did not present the government with a problem as it has been an enthusiastic supporter of the agreement. But, now that the flaws in the agreement have been exposed, or shown to be "hocus-pocus" as Congdon maintains, the provisions cannot be changed unilaterally by the British government. They are now part of EU law so, in order to achieve change, all we can do, as Cameron euphemistically put it, is have "…our regulatory authorities, together with the European regulators," address "this difficult issue."
And that equivocation is also part of the problem. One might ask why, if Cameron is now so (rightly) certain as to where the problem lies, his shadow chancellor has not raised it before.
To be fair to him, he has. He raised it on 21 April 2008 in the House of Commons in response to a statement by Alistair Darling on "financial stability". But it was only one sentence where he told Darling that the moves he had announced "should include reforms to the Basel accords."
Then, in a Newsnight interview on 17 September, just a few days ago, he mentioned it again, a reference which met with the approval of Telegraphcolumnist Gerald Warner, who noted:Osborne did not overreact to the crisis by rushing to propose a host of regulations to monitor the stable door now that the horse has bolted. Instead, he proposed revisiting the Basel II Accord, which is now four years old.
Thus, while Osborne has belatedly come to the view shared by Spencer and Congdon, and evidently passed this view to his boss, neither he nor Cameron have mentioned Directive 2006/49/EC, nor even the European Union. Yet it is the Directive which must be changed.
Yesterday, Cameron entitled his speech, "Together we will find a way through". What he did not specify, however, was how he was going to "find a way through" the EU labyrinth to remove a damaging piece of legislation that is at the heart of this crisis.
Thus, while Osborne is accusing Labour of being "in denial" over its role in the financial crisis, the Conservatives too are indulging in their own form of denial.
The elephant has re-acquired its cloak of invisibility.
The picture shows the headquarters of the Bank for International Settlements in Basel, which hosts the Basel Committee on Banking Supervision meetings
Saturday 3 January 2009
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