Spain’s banks caught with hand in cookie jar
But back in 2008 and early 2009, regulators in Spain were riding high after their country’s banks seemed to have dodged the financial crisis with minimal losses.
A big reason for their success, the regulators said, was an accounting technique called dynamic provisioning.
By this, they meant that Spain’s banks had set aside rainy-day loan-loss reserves on their books during boom years. The purpose, they said, was to build up a buffer in good times for use in bad times. This is not the way accounting standards usually work.
Normally the rules say companies can record losses, or provisions, only when bad loans are specifically identified.
What is now obvious is that Spain’s banks weren’t reporting all of their losses when they should have. One of the catalysts for last weekend’s bailout request was the decision last month by the Bankia group, Spain’s third-largest lender, to restate its 2011 results to show a €3.3bn loss rather than a €40.9m profit. Looking back, we should have known Spain’s banks would end up this way, and that their reported results bore no relation to reality.
Dynamic provisioning is a euphemism for an old balance-sheet trick called cookie-jar accounting. The point is to understate past profits and shift them into later periods, so that companies can mask volatility and bury future losses. Spain’s banks began using the method in 2000 because their regulator, the Bank of Spain, required them to.
The danger with the technique is it can make companies look healthy when they are actually quite ill, sometimes for years, until they finally deplete their excess reserves and crash.
The practice also clashed with International Financial Reporting Standards, which Spain adopted several years ago, along with the rest of Europe. EU officials knew this and let Spain proceed with its own brand of accounting anyway.
A candid advocate of the approach was Charlie McCreevy, EU’s commissioner for financial services from 2004 to 2010 and previously Irish finance minister.
During an Apr 2009 meeting of the monitoring board that oversees the International Accounting Standards Board’s trustees, McCreevy said he knew Spain’s banks were violating the board’s rules. This was fine with him, he said.
“They didn’t implement IFRS, and our regulations said from the 1st Jan 2005 all publicly listed companies had to implement IFRS,” he said, according to a transcript of the meeting on the monitoring board’s website.
McCreevy, who at the time was the chief enforcer of EU laws affecting banking and markets, went on: “The rules did not allow the dynamic provisioning that the Spanish banks did, and the Spanish banking regulator insisted that they still have the dynamic provisioning. And they did so, but I strictly speaking should have taken action against them.”
Why didn’t he act? McCreevy said he was a fan of dynamic provisioning. “Why am I like that? Well, I’m old enough to remember when I was a young student that in my country that I know best, banks weren’t allowed to publish their results in detail,” he said. “Why? Because we felt if everybody saw the reserves, etc, it would create maybe a run on the banks.”
So to sum up this way of thinking: The best system is one that lets banks hide their financial condition from the public. Barring that, it’s acceptable for banks to violate accounting standards, if that’s what it takes to navigate a crisis. The proof is Spain’s banks survived the 2008 financial meltdown better than most.
Except now we know they didn’t. They merely postponed their reckoning, making it inevitably more expensive. Someday maybe the world’s leaders will learn that masking losses undermines investor confidence and makes crises worse. We can only hope they don’t manage to blow up the whole financial system first.
* Jonathan Weil is a Bloomberg View columnist The opinions expressed are his own.
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