Accountants who check the books of Britain’s banks must sharpen their act or face being ordered to take corrective measures, the sector’s watchdog said in a report showing how a core lesson from the financial crisis has yet to be applied.
The Financial Reporting Council (FRC) said in its annual audit quality inspections report that there was a significant improvement in audits of listed companies in general, but the banking sector continued to lag.
Paul George, the FRC’s executive director for conduct, said: “We have not seen enough progress in the quality of bank and building society audits, which continues to be generally below that of other types of entities.”
The inspections during 2013 and 2014 covered audits for the year that ended December 2012. They included the books of five banks and five building societies, all unnamed. None were “good” – the top grading – while 56 per cent needed improvements.
In particular, there was no significant improvement in how accountants check the way banks set aside capital to cover souring loans, known as loan-loss provisioning.
Too low levels of capital forced taxpayers to shore up lenders during the financial crisis. It also prompted policymakers to ask auditors why they gave banks a clean bill of health just months before they had to be rescued.
The FRC said: “Weaknesses in the testing of loan impairment models and related assumptions were key issues. Insufficient challenge of management or the failure to obtain further evidence to support provisioning judgments were common themes.”
Britain’s big banks are all audited by one of the “big four” accounting firms – EY, Deloitte, KPMG and PwC. Deloitte said: “The FRC’s report provides a balanced view of the focus and results of its inspection, and we agree with its overall conclusions and findings.”
Auditors will have to work hard to improve continuously, EY said, while PwC said it has put in place a comprehensive action plan to embrace recommendations in the watchdog’s report. KPMG said the review showed that most of its audits were either good or required only limited improvements and it would redouble efforts to ensure that no audit required substantial improvement.
Britain’s competition watchdog and the European Union are bringing in rules forcing companies to change accountants more frequently to avoid cosy relationships.
Barclays is changing its auditor PwC for the first time in 120 years. Lloyds and Royal Bank of Scotland may follow suit, but given the complexity of lenders, the switching will almost certainly be between the big four.
George said the FRC is looking for a “step change” in audit quality at banks when it publishes the results of a separate broad review of bank book-keeping in the autumn. He added: “If we do not see the level of progress that we expect then clearly enforcement would be something we would need to consider.”