* FRC says auditors don't question banks enough
* FRC to get bigger stick to spur better audits
* Fear that falling fees may hit audit quality
By Huw Jones
LONDON, June 13 (Reuters) - Audits of British banks have improved but accountants must challenge more of what their clients tell them about bad loans on their books, the accounting industry watchdog said on Wednesday.
Many policymakers blame insufficient auditor scepticism for clean bills of health given to banks just before they had to be rescued by taxpayers in the 2007-09 financial crisis.
It triggered political scrutiny of the sector, leading to a draft European Union law that proposes mandatory "rotation" or changing auditors every certain number of years, a step the United States is also considering.
But the UK's Financial Reporting Council (FRC) said in its annual report on Wednesday that reforms have yet to bear fruit in making auditors more sceptical about what they are told.
Across all industry sectors auditors are not questioning enough if the value or "goodwill" of acquisitions made in the good times are being written down to reflect a weaker market.
And some audit teams did not always fully understand the accounting and reporting requirements in this area.
"We do think more action is required," the FRC's director of auditing, Paul George told Reuters.
The regulator is due to get more powers to fine and otherwise sanction auditors and the accounting profession bodies, a move George said will provide additional stimulus to get faster improvements in audit quality.
"I see these additional powers very much as being a backstop. I believe the actions firms are taking should further accelerate improvements in performance," George said.
The FRC is already working closely with the Financial Services Authority on the information banks give on provisioning for possible defaults on mortgages and the extent of their forebearance.
"We believe there is more to be done," George said.
The FRC's annual report on audit quality looked at more than 80 audits, including all banks and building societies as well as firms from other sectors. They were mostly conducted by the "Big Four": KPMG, Deloitte, PricewaterhouseCoopers and Ernst & Young.
Only one audit of a financial firm needed significant improvements.
But the push to improve audit quality further could be hampered by a big drop in audit fees as businesses are tendering their audits far more frequently than in the past in a bid to cut costs.
The watchdog is worried lower fees will lead to fewer hours spent on checking books as auditor margins come under strain.
"We are seeing some signs that our concerns are happening and we are encouraging the firms to put in some better safeguards centrally, and that audit committees should also be alert to this," George said.
FRC findings that audit tendering has increased significantly and fees falling could help the Big Four show Britain's Competition Commission that the audit market is competitive.
The Commission is probing and sector and due to say by November whether there should be "remedies" in a market where the Big Four check the books of the vast majority of large companies.
The FRC said that of 84 audits across all industries looked at in 2011/12, 39 were good with only few tweaks needed, down 1 from 2010/11.
There was a jump in the number of audits that were acceptable with improvements required, to 37 from 30. Eight audits needed significant improvements, down from 11.