Capital Markets

PwC: Banks’ Disclosures Lack Substance

Based on 2007 financial reports, investors could have a hard time understanding global banks' risk positions and fair value measurements, according...
Sarah JohnsonAugust 14, 2008

A new study of 2007 financial reports by large banks gently criticizes banks for holding back useful information from investors. But the report, by PricewaterhouseCoopers, also gives the global heavies a break, noting that the financial institutions were dealing with new accounting rules and a credit crunch.

However, PwC notes that failures in the credit markets will have investors demanding more information about the risk financial institutions carry, both on and off their balance sheets, in future annual reports. Indeed, the accounting firm says, the banks would do well to better explain the thinking that goes on behind their measurements of their financial instruments and how they manage risk. As it is, they tended to do the least amount of work required under new accounting rules that went into effect last year.

In the report, released this week, PwC reviewed the 2007 financial statements of 22 global banks that use U.S. GAAP and international financial reporting standards. Half of those banks, which include Bank of America, Citigroup, Credit Suisse, JP Morgan Chase, and UBS, are registered with the Securities and Exchange Commission.

For the IFRS users, 2007 was the first time they applied IFRS 7, the International Accounting Standards Board’s rule for disclosures related to financial instruments. The rule was issued under the premise that it would lead to better transparency about firms’ financial risks, PwC contends. However, most banks “did not take the opportunity to present a truly comprehensive and clear picture of how they manage risk, opting instead to focus on achieving compliance with IFRS 7 minimum requirements,” PwC wrote.

The banks’ IFRS 7 risk disclosures were often hard to find, PwC noted. While the banks acknowledged their industry’s exposure to problems in the U.S. subprime mortgage market, they did not share how they were individually affected. The report suggests that better disclosures on the parts of banks about their exposures and risk management could “restore market confidence.”

U.S. GAAP preparers also had to provide better information about financial instruments that are measured under fair value, by way of FAS 157, the Financial Accounting Standards Board’s relatively new standard on how to make fair value measurements. (IASB is working on equivalent guidance for fair value measurement and expects to release an exposure draft on the topic early next year. In the meantime, PwC says, FAS 157 has put more pressure on overseas firms to be more forthcoming in their fair-value disclosures.)

In its report, PwC said the U.S. GAAP-reporting banks generally followed the new rules correctly, but could improve by giving investors a better understanding of how they applied fair value accounting. The firm suggests banks give more details about their valuation methodologies, the assumptions that go into those valuations, and be more consistent in their reporting. Moreover, if any of those valuations or assumptions change, they should explain why, PwC says.

Regulators have made similar requests to financial-statement preparers, and have cast a particularly close eye on fair-value estimates derived from “unobservable” market data. Under the FASB framework in FAS 157, company executives use their own judgment to estimate how much a hypothetical third party would pay for an asset in an illiquid market. Earlier this year, the SEC told CFOs they will have to explain the reasoning behind those estimates.