Ladies and gentlemen,
At a dinner party one should eat wisely but not too well, and talk
well but not too wisely. Bearing these words of William Somerset Maugham
in mind, I will do my best to neither bore you with technical stuff,
nor to spoil your appetite with too wise remarks. But if I may just stay
with that quote for a moment: Shakespeare lovers among you may have
recognized that it is a paraphrase of a speech by Othello, in which he
describes himself as "one that lov'd not wisely but too well". His
tragedy is that he allows his reading of reality to be coloured by
jealousy (and Iago's deceit), which destroys his trust in his wife's
love and fidelity.
I hope you won't find it too heroic a leap from here to the
observation that the financial markets in which central banks,
commercial banks and other players operate are crucially dependent on
trust. Trust in the basic integrity of the institutions and corporations
that make up the market, in the rules by which they play, and in the
information that they disclose to the market.
1. Central banks
So let me start with some thoughts about the evolution of central
banking and the importance of financial reporting in this process.
Central banks have always been confronted with changing in economic
and legal conditions in their activity. These changes are often the
result of crisis and the danger of financial and economic collapse.
Permit me, in its 200th anniversary year, to cite the example of the
Austrian central bank, one of the oldest central banks in Europe, which
was created in a crisis situation after the long years of the Napoleonic
wars to stabilize the troubled economic and financial situation of the
Austrian Empire, and in particular to restore trust in the national
currency.
Public trust in the national currency was the starting point for the
need to publish financial statements of the Austrian central bank. Our
bank was founded after the Napoleonic Wars and the Congress of Vienna in
June 1816, as a better trusted agent and intermediate with commercial
banks after the Austrian-Empire had issued paper money on a grand scale.
The first monthly financial statements were published in 1848 (so
called Revolution Year in Austria and much of Europe) a year of public
riots against the government in the Austrian Empire. The purpose of the
publication was to reassure the public that the paper money was covered
by adequate silver holdings. After some years of prosperity the first
significant financial crisis then also triggered the publication of the
central bank's balance sheets from 1863 onwards. The legal necessity to
publish weekly balance sheets in order to prove the coverage of the
national currency by adequate assets like gold holdings and foreign
currency holdings of the Austrian central bank continued until 1999,
when we joined the Eurosystem. From that point on the ECB continued with
this task for all National central banks of the Eurosystem by its
consolidated weekly financial statement until today.
Nowadays, the tasks of a central bank in the framework of the
European Economic and Monetary Union are well defined. They include both
the general aim of price and financial stability, and the development,
the implementation and the monitoring of compliance with, new
regulations. To secure the objective of price stability, the
independence of the central bank, especially with regard to monetary and
macroprudential policy, is a major prerequisite. It has been recognized
that the "leaning-against-the-wind" function requires a central bank
that is not subject to the pressures of day-to-day politics. For the
government and/or parliament to cede this power to the central bank,
they need to have the assurance of extensive central bank accountability
and transparency; always tempered, of course, by the amount of
confidentiality necessary in order to remain effective, and indeed
independent, for example with regard to the voting behaviour of
individual monetary policy committee members.
A central bank's monetary policy decisions are discussed in the mass
media and the general public, and not only the decisions themselves but
also their financial results. Financial results have become more
important - and more difficult to earn - in a "new normal" environment
of ultra low interest rates and rising costs stemming from increasing
tasks of central banks, and also in the context of issues like income
and loss sharing which are typical for currency systems consisting of
many countries, like the Eurosystem.
Central banks' capital adequacy and the definition of financial
buffers are usually caught in a tension between, on the one hand,
domestic laws, which vary considerably in their definitions of capital
and its components, and, on the other hand, systemic balance sheet
growth, which is a necessary consequence of central banks' interventions
in the financial and economic crisis. As central banks are mostly
government institutions or publicly owned companies, their capital is
mostly limited by domestic laws. In cases of substantial balance sheet
growth, existing rules might not fit anymore. At such times the
financial reporting framework might have to provide possibilities for
new appropriate solutions.
One such solution might be for recapitalisation by domestic
governments after losses, or for potential future losses, to be made
mandatory, however such requirements are often difficult to get approved
by parliament and by public opinion.
Designing the adequate level and composition of the capital of a
central bank is a sensitive challenge. One has, among a number of other
internal and external factors, to take account of the central bank's
legal environment, the relationship to the government, and its special
tasks, like lender-of-last-resort function, or a fiscal agent-function
vis-? - vis the state. In any event, a central bank's capital must be
sufficient to maintain its independence from the political sphere, and
to provide a buffer for the inevitable price volatility resulting from
the current investment environment.
The individually adequate balance for each central bank between a
suitable accounting framework, profit distribution rules and the ability
to hold or reserve adequate amounts for loss coverage is the key for
financial independence. When you apply the accounting rules to arrive at
the annual financial result, you are then confronted with the question
of applying rules for the distribution of profits. These rules can be
classified in six general legal profit and loss schemes according to a
recent ECB study on profit distribution and loss coverage of central
banks (by Werner Studener and his colleagues).
The study, based on the experience of 57 central banks that provided
data for the ECB analysis, confirms what the BIS found in 2013, namely
that there is no one-size-fits-all solution for central banks, neither
for the level of capital and financial buffers nor for profit
distribution and loss coverage; nor, indeed, for recapitalisation rules.
However, there is evidence that these topics are interconnected and a
set of guiding principles have been identified, which help to find an
individual balance.
2. Commercial banks and corporates
As I said earlier, financial reporting is a key issue, not only for
central banks, but for all kinds of businesses and, of course,
commercial banks as well. Modern historians agree that the invention of
double entry bookkeeping in the fifteenth century was a major driver for
modern economic pursuit and capitalism, as it first introduced the
maxim "Increase your equity!" Or, in the words of Charlie Munger (of
Berkshire Hathaway): "Double entry bookkeeping was a hell of an
invention."
Now even more than it did back then, accounting poses a considerable
challenge and uses huge resources. The need to provide a true and fair
view of ever more complex and sophisticated transactions, to the
satisfaction of an ever wider range of stakeholders, has led to rather
complex accounting rules nowadays. As Sir David Tweedie, the former
chair of the IASB once said, "anyone who thinks he understands IAS 39,
has not read it properly."
But time will tell if IFRS 9 is capable of doing a better job.
The new impairment model, with its paradigm change from allowances
based on incurred losses to risk provisions based on expected losses,
will have a huge impact on financial reports of banks and their
analysis. It can be expected to lead to considerably increased
impairments at initial application, and over time to a higher degree of
volatility.
Will IFRS 9 add to the trustworthiness of accounts? The primary aim
of IFRS 9 is to establish a significantly improved accounting standard
for presenting users of financial statements with information that is
relevant, useful, and more comprehensive in assessing the amounts,
timing and uncertainty of a firm's cash flows from financial
instruments. Provisions for bad debts will be larger and maybe more
volatile, and adopting the new rules will require a lot of time, effort
and money. As of today, I understand, it is unclear if the new
accounting rules will strengthen the trustworthiness of accounts because
of the complexity of the standard.
3. Banking supervision
Another demanding issue, especially in the context of European
integration, and of banking supervision in the Banking Union, is the
variety of legal bases for accounting rules. On the one hand, certain
jurisdictions oblige preparers to base their financial statements
entirely on IFRS. On the other hand, several member states still rely on
their national GAAPs, at least for financial statements on solo level.
Nowadays we find advocates of both approaches. The ones argue that
uniform accounting rules are key in an economic union. The others favor
the retention of national GAAPs which, compared to IFRS, in several ways
incorporate a greater degree of prudence.
In the context of European supervision, we are currently seeing
efforts to overcome this diversity in accounting rules for the purpose
of developing a set of key risk indicators for cross-sectoral and
cross-country comparisons, by translating national-GAAP numbers of banks
to, for the lack of a better word, fictitious IFRS data.
Therefore, as supervisors we are moving in an area of conflict
between the goal of achieving a level playing field and of avoiding the
use of inaccurate data based on vague translations from nGAAP to IFRS.
The trade-off can also be seen as that between the attempt to capture
"reality" as faithfully as possible against the need to develop and
apply a robust - even if not perfect - signalling tool for European
supervisory action. This seems to be rather dangerous. Eventually it can
be used to identify trends in the industry but certainly not to trigger
supervisory action on a single bank.
4. Accountants and auditors
I cannot conclude these remarks without at least touching on an
essential component of a trust-based environment, and that is the
accounting profession. The accounting frameworks, as we have seen,
attempt to reconcile the information needs of a variety of stakeholders
and will change along with those needs and with the economic setting.
What remains in all circumstances, though, is the need for accountancy
practitioners and audit professionals who have the skills to understand
the transactions and relationships underlying the financial reports, and
who can manage their conflicts of interest to the highest standard of
international practice. (I may add, from my particular vantage point as a
prudential supervisor of banks, that we are frequently amazed at the
fragility of audited bank accounts under supervisory scrutiny, and at
what are often accepted as plausible assumptions.)
In order to support confidence in the statutory audit, it has been
necessary to implement different reforms at the European level. These
include the mandatory external rotation of auditors to avoid
dependencies in companies of public interest and the restriction of
non-audit services by the auditor during the audit mandate. Additional
measures, which lead to an increase in the quality of audit were also
necessary. This applies to the mandatory application of International
Standards on Auditing by the auditors and quality assurance checks by
national authorities. An increased audit quality will also strengthen
the confidence in financial statements and audit reports, that are able
to withstand inspection by enforcement bodies.
5. Conclusion
And so we see that for the financial system to have the trust of
those inside it and those outside, we need four things to be in place to
a significant degree:
- Transparency of methodology and outcomes;
- Well designed tools and rules;
- Well balanced institutional checks and balances, including self-correcting and learning mechanisms.
And finally, personal integrity of practitioners. This is key. In the
end, both the auditors and the financial directors who sign off on
financial reports, and their supervisors, must be constantly aware of
their fiduciary duty to the public and to the continued functioning of
the delicately balanced, fragile, trust-based system they operate in.
Thank you for your attention.
