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Tougher capital audits loom for lenders
From the Financial Times of Mon, 15 Dec 2014 00:03:23 GMT

British banks will have their calculations of how much capital they hold assessed by auditors for the first time under proposals to be announced this week ahead of the Bank of England’s stress tests of leading lenders.

The BoE’s Prudential Regulation Authority has been pushing auditors to draw up plans for conducting regular assessments of how banks work out their levels of capital and the riskiness of their assets.

Concern that banks underestimate how risky their assets are and overestimate how much capital they hold has increased since the financial crisis exposed the financial flimsiness of lenders that until then had published seemingly strong figures.

The reliability of banks’ capital calculations has also been called into question after a number of embarrassing errors. Royal Bank of Scotland and Bank of America were both forced to admit this year that they had overstated their capital in stress tests.

This week, the Institute of Chartered Accountants in England and Wales will publish proposals to draw up a framework for providing banks with assurance either for the capital figures themselves or for the controls used in calculating them.

This would bring the UK into line with other countries, such as Australia, Switzerland and Germany, where banks already have their capital calculations assured by auditors.

The ICAEW will say that it is starting to canvas investors, audit committees, regulators and creditors about the proposals and aims to issue a paper for formal consultation next year.

“There is a lot of subjectivity in the capital rules for banks,” said Iain Coke, head of ICAEW’s financial services faculty. “The ways they implement those rules may not be as strong as they might be. We are hearing more investors and analysts raising concerns about this.”

The BoE, which declined to comment, may issue a rule requiring banks to employ auditors to carry out an external assessment of their capital calculations.

Because the main measure of financial strength in a bank is the level of capital it holds against its risk-weighted assets, there is a big potential for a bank to boost its perceived health by underestimating the riskiness of its assets.

The amount of capital held by UK banks will come into sharp focus on Tuesday, when the PRA is due to publish the results of its debut stress tests of the eight largest UK lenders.

The Co-operative Bank is the only group expected to fail a stress test, which measures how much capital lenders would have in an adverse economic scenario, including a 35 per cent fall in house prices and a substantial rise in unemployment and interest rates.

The test is a crucial hurdle for the banks, particularly for Lloyds Banking Group, which needs to achieve a solid result to gain the regulator’s approval for pressing ahead with its plan to restart dividend payments next year.

Last year, the BoE conducted a “capital shortfall exercise” that found five of the UK’s eight biggest banks were suffering from a £27.1bn gap in their capital requirements at the end of 2012.

It singled out the Co-op Bank, Barclays, Lloyds, RBS and Nationwide for criticism. The capital shortfall partly resulted from what the regulator considered overly optimistic assessments of how risky their assets were.

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