UK Regulator Rejects Using Financial Accounting Standards to Promote Stability

In an effort to refute the growing global consensus that financial accounting must change because its pro-cyclicality contributed to the financial crisis, the UK accounting overseer said that people proposing to amend accounting rules to make them less pro-cyclical must believe that investors cannot be trusted with the unadjusted numbers produced by the application of accounting standards. In remarks at the Financial Reporting Council’s annual meeting, CEO Paul Boyle emphasized that it is dangerous to give accounting an explicit role in promoting financial stability in addition to its traditional role of providing useful information to investors to inform their investment decision.

One may just as well argue that house price statistics are pro-cyclical, said the executive director, since reports of rising prices drive consumers to make purchase at higher values, thereby further driving up prices, with reports of falling prices having the opposite effect. While acknowledging that current accounting standards need improvement, he urged regulators and policy makers to assess any proposed changes with a clear understanding of the purposes of financial accounting.

In that regard, he said that financial accounting rules and standards are designed to measure the financial performance of a company in as neutral a way as possible. It is not surprising that banks report substantial profits during good times and losses during bad times. This is the job of financial accounting, to reflect the economic cycle, he noted, which is a good characteristic of a financial measurement system. It is not in the public interest to adjust the numbers in the interest of financial stability.

Further, the way in which investors will react to accounting information is not easy to determine in advance since it will be influenced by a number of variables. Thus, it is not reasonable to ask FASB and the IASB to predict those reactions or to predict whether those reactions are good, in making their measurement choices.

Mr. Boyle’s defense of traditional accounting come against the backdrop of efforts by US, Chinese and EU regulators and policy makers to lessen the pro-cyclical effect of certain accounting standards. For example, the Obama Administration’s blueprint for reform noted that certain aspects of accounting standards have had pro-cyclical tendencies, meaning that they have tended to amplify business cycles, adding that the interpretation and application of fair value accounting standards during the crisis raised significant pro-cyclicality concern. Similarly, the Governor of the People’s Bank of China identified fair value accounting as a factor that worked to exacerbate the financial crisis.

At a meeting of G-20 central bankers, Zhou Xiaochuan said that the problems of fair value accounting have been exposed by the current crisis. Governor Zhou recommended implementation of circuit-breakers to stem the pro-cyclicality caused by mark-to-market and fair value accounting in specific situations. Axel Weber, President of the Deutsche Bundesbank indicated that effective reform must also address fair value accounting which, in his view, amplifies the cyclicality of leverage.

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