Herz: Give Banks More Freedom from GAAP

The Financial Accounting Standards Board chairman calls for a greater "decoupling" of GAAP from bank regulators' capital requirements.
Sarah JohnsonDecember 8, 2009

Robert Herz, chairman of the Financial Accounting Standards Board, wants to loosen the ties between accounting standards and banks’ capital thresholds.

At the American Institute of Certified Public Accountants’s annual meeting Tuesday, Herz called for a “greater decoupling of bank regulation from U.S. GAAP reporting requirements,” according to his prepared speech. He has previously voiced his support for the concept.

Herz noted that while bank regulators use financial statements based on U.S. generally accepted accounting principles as a reference point for determining a financial institution’s capital needs, the standards “do not dictate regulatory requirements.”

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To be sure, Herz is trying to quell any misconceptions about how deep the connection is between accounting rules and bank regulatory requirements. Such “confusion” (his word) has resulted in U.S. and international standard-setters feeling the heat from politicians and bank lobbyists since the credit markets began to crumble two years ago.

Most likely, the chairman would prefer to keep accounting rulemaking and banking regulation separate — in the minds of observers, as well as in practice — to repair FASB’s independence, which has been tampered with in the past several months as bank lobbyists and lawmakers pressured the board and its international counterpart to ease fair-value accounting rules. The separation would put the onus on banking regulators to make changes in how they determine financial institutions’ baseline capital needs.

Herz acknowledged that investors’ and regulators’ needs differ when it comes to the merits of the concept of measuring financial instruments according to current market values. Cost accounting may be more useful for regulators, he noted, for valuations of some assets in determining capital requirements. However, he added, “in instances in which the needs of regulators deviate from the informational requirements of investors, the reporting to investors should not be subordinated to the needs of regulators.”

Moreover, he said, “handcuffing regulators to GAAP or distorting GAAP to always fit the needs of regulators is inconsistent with the different purposes of financial reporting and prudential regulation.”

Herz suggested that one way banking regulations could change is by designing capital-reserve policies that would take into account dips in the economy (by requiring more in banks’ capital reserves) and times of growth (when capital reserves could be smaller). Last year David Tweedie, chairman of the International Accounting Standards Board, similarly called for a delinking of GAAP and bank regulations by saying rulemakers should work to both preserve the integrity of fair-value accounting and provide regulators with more leeway for adjusting capital requirements.

Nearly a year ago, the Securities and Exchange Commission concluded in a congressionally mandated study that fair-value rules shouldn’t be suspended and weren’t to blame for bank failures. The commission found that fair-value measurements had been applied to only a small number of assets in 22 failed banks, and the fair-value-related losses did not have a “significant” effect on the banks’ capital.

But that finding hasn’t stopped lawmakers from railing against the rules for causing the country’s financial woes. Standard-setters on both sides of the Atlantic have responded with rushed guidance on the rules that appear to loosen their implementation — and hurt the boards’ independence status.

Citing the independence issue, the Shadow Financial Regulatory Committee, a group of experts on the financial-services industry sponsored by the American Enterprise Institute, has similarly suggested keeping standard-setting separate from regulatory-capital measurements. Doing so would preserve the financial reporting needed by investors while giving bank regulators the flexibility to deviate from GAAP for their definitions of regulatory capital.

“The regulators [would] get to use the inputs provided by the accountants in whatever way they want, but they do not get to set the accounting measurements, as this could hurt transparency,” explained Christian Leuz, a member of the committee and a professor at the University of Chicago Booth School of Business.