Flawed accounting standards led UK and Irish banks to overstate their solvency and directly contributed to banking losses of over £150bn.

The Local Authority Pension Fund Forum (LAPFF), whose 55 members have combined assets of £100bn, has today published a major study into the failures of UK and Irish banks during the financial crisis. 

The report, UK and Irish bank capital losses – post-mortem, finds that the failure to identify accounting standard setting as a root cause of the initial phase of the banking crisis led to a "misdiagnosis‟ of the problem as one of liquidity rather than solvency.

 The Forum argues that a relatively simple error was introduced into the financial accounting system in 2005 under International Financial Reporting Standards “IFRS,” with severely detrimental effects on financial governance and regulatory oversight. The result of the error was the near collapse of the UK and Irish banking systems.

 LAPFF believes that in practice IFRS has run contrary to the "true and fair" view in accounting, and painted a false picture of the solvency of financial institutions. Banks that appeared to be solvent within a few months required an enormous amount of taxpayer support in order to survive. However shareholders have not, to date, seriously questioned why the weak position of the banks was not flagged in their financial reporting. LAPFF's report is intended to highlight this major fault.

The Forum's analysis shows that the UK and Ireland were at risk because they adopted IFRS more comprehensively than other parts of the EU. As such, they were amongst the hardest hit in the first wave of the crisis. The Forum research estimates that the total loss of capital of UK and Irish banks has been in excess of £150bn, with investor losses even greater.

However, in contrast to popular understanding, the refinancing of the UK and Irish banking systems has been predominantly to make good losses on ordinary lending, rather than investment bank trading book losses.

LAPFF chair Ian Greenwood said: “The failure of several major UK and Irish banks had a major impact on our members in particular, and market confidence in general. Therefore it is vital that we understand precisely what went wrong, including why the failures were initially misdiagnosed as a problem of liquidity, rather than a capital crisis. Our analysis clearly points to the fact that flawed international financial reporting standards played a significant contributory role. This implies that significant reform of both accounting standards and the standard setters is required.”