Banks Exaggerate Profits to Boost Bonuses, says Adam Smith Institute

Banks are able to deceive investors about the scale of their profits and boost their staff bonuses under current financial regulations, according to a report by a former banker.

The Law of Opposites, by Gordon Kerr, calls for changes to the International Financial Reporting Standards (IFRS) which he claims lets banks recognise hopes of future income as current profit.

"Unless we end false accounting, bank regulation will remain impossible and pointless," he said in the report, published by the Adam Smith Institute.

The report focuses on several ways banks can boost profits, such as purchasing a credit default swap or similar protection to provide "certainty" to cash flows when a supplier of the protection is likely to default if the insured event occurs

Kerr also claims that the net present value of future cash flows can be recognised as profits, despite hugely optimistic forecasts.

Meanwhile banks do not need to make provision for expected losses when calculating profit.

Kerr endorsed the adoption of MP Steve Baker's 10-minute rule bill, which seeks to require UK banks to prepare accounts presenting derivatives and financial erxposures at the lower of historic cost and mark to market values.

"That simple change would improve accounting transparency and help regulators to protect taxpayers. It would refocus banks on making productive loans instead of operating the derivatives merry-go-round," Baker said.

Kerr agrees that something needs to change, but believes that the "fundamental insovency of big banks does not appear to be understood".

"The consequences of a continued failure to fix the banking system will be the fundamental destabilisation of our societies," he warned.