Bit of accountability is what the doctor ordered

PUBLISHED : Thursday, 29 October, 1998, 12:00am
UPDATED : Thursday, 29 October, 1998, 12:00am

Years ago when I was an investment analyst, I had a friend who was a manager for one of the local security firms that transport cash and valuables between offices and bank vaults.

One day he had to organise a routine pick-up of several heavy crates from the airport. It was probably gold but he wasn't sure.

The delivery, however, was not routine. The client, a small local bank which shall remain nameless, instructed him to drive to a specified street corner, exchange a password with a man who could be identified by some peculiarity of costume and then deliver the shipment to an address he would supply.

'Why don't we just take it straight to your main branch as usual?' my friend said.

'Can't do that,' came the reply. 'We've got the auditors in and they don't know we deal in this stuff.' If the big accounting firms have said it once, they've said it a hundred times. Against this sort of fraudulent practice, carefully and cleverly carried out, their safeguards cannot be guaranteed.

We now have the United Nations Conference on Trade and Development (Unctad) blaming the Big Five international accounting firms for not giving sufficient warning of the Asian crisis.

A recently released Unctad report said investors and lenders were given a false sense of assurance that Asian banks were strong when they saw the firms' names on the audited financial statements of these institutions.

It concluded that the crisis would have been detected sooner if banks and companies had been forced to follow stronger accounting rules.

This is probably true but it does not mean the big accounting firms are the culprits. When auditing banks, they are required to abide by the rules in the countries in which they operate.

They may, for instance, think it makes sense to declare loans non-performing the moment an interest payment has been missed and to provide fully against these loans if no interest has been paid for three months.

But if the rules say it's three months for a non-performing declaration, six months before provisions are required and then only a third of the loan needs to be written down, then there is not much the auditors can do if the banks they are auditing want nothing tighter than the rules.

There is also little tighter accounting rules can do to prevent clever fraud.

Sometimes it can be picked up but even then it can take years for the evidence to surface. When it does, it's best dealt with by the police, not the auditors.

Auditors can be blamed only if they are accomplices to fraud. There were two big cases in Hong Kong in the early 1980s were this appeared to have happened but nothing on a large scale since, and it has not been a feature of the prevailing Asian crisis.

Unctad and the World Bank - which is making the same complaint - are, in fact, playing the game of it's-not-our-fault. They want Asian companies to adopt tighter international accounting standards and, if possible, US standards on the reasoning that there would have been more forewarning this way.

These tighter standards, however, did not appear to have put big international banks in a position to see that they were taking enormous currency risks up to the middle of last year in lending huge amounts of US dollars to local Asian companies with no US dollar revenues. There was no warning from them that Asia could suffer a financial crisis because of it.

Yet this flood of ill-advised lending was one of the biggest reasons that Asia went off the rails. There is not much chance that tighter rules in Asia would have given warning of the crisis if tighter rules for foreign lenders to Asia did not.

In fact, one of the reasons that international banks were willing to take such risks is that they expected big multilateral institutions like the United Nations, the World Bank and the International Monetary Fund to enforce repayment of their loans through government bailout packages if things went wrong. It is exactly what has happened.

So it's no good blaming Asian accounting standards. Physician, heal thyself.