A Bill to expose banks’ false profits, overstated capital and hidden losses

My Financial Services (Regulation of Derivatives) Bill has now been printed, ready for second reading on 10 June. You can obtain the PDF here and track the Bill’s progress here. The press release, including links to background evidence and press coverage, is here.

When I introduced my Bill on 15 March, I explained how the accounting rules for banks incentivize trading in derivatives by enabling unrealized profits to be booked up-front, leading to large but unjustified bonuses and dividends.

On 30th March, the House of Lords Economic Affairs Committee published a report recommending that the Government reassert prudence as a guiding principle. That is what my Bill does and I hope the Government will adopt it.

While complying with the rules, banks are producing accounts that grossly inflate their profits and capital in three ways. First, using IFRS mark-to-market and mark-to-model accounting, banks record unrealized gains in investments as profits. Second, IFRS prevents banks from making prudent provision for expected loan losses by allowing recognition only of incurred losses. Third, IFRS encourages banks not to deduct staff compensation from profits. Taken together, these flaws mean that banks’ accounts under IFRS are at once rule-compliant and dangerously misleading.

By way of example, we have deduced from the accounts of the UK Asset Protection Scheme that RBS may be overstating capital by as much as £25bn.

Boards take decisions based on their accounts. If the accounts are misleading, is it any wonder that boards and regulators are failing shareholders and taxpayers? The public are furious about the injustices manufactured by the banking system, and they are right to be, but how much greater is the injustice if grotesque bonuses are based on false profits?

Banks are living in a fools’ paradise in which their boards cannot get a firm grip on vital measures like capital and profit. That is plain wrong.

Thanks to the European Union, the UK cannot simply mandate prudent accounting in compliance with UK Companies Law but we can require parallel accounting to British standards while international negotiations proceed. That is why I am calling on the Government to adopt my Bill.