ECB Noyer: Need accounting change once crisis passed

WASHINGTON (Reuters) - Accounting rules used to set a value on the assets held by banks need to be overhauled but it would be wrong to move during the financial crisis, European Central Bank governing council member Christian Noyer said.

How to put a value on the complex array of structured credit products owned by banks has been one of the key issues at the heart of the turmoil sweeping global financial markets and there have been widespread calls for an overhaul of the rules.

But in a paper published in the Bank of France's Financial Stability Review for October on Sunday, Noyer, who is also Governor of the Bank of France and head of the French Banking Commission, cautioned against rushing to issue new regulations.

"Noting that valuation rules may not be optimal for all instruments in all market circumstances does not mean that they should be changed in the midst of a crisis," he wrote.

The paper was prepared before Sunday's emergency meeting of European leaders, who decided to allow firms more flexibility in applying accounting rules given the current "exceptional market circumstances," a move welcomed by the Bank of France.

Noyer's comments, concerning a wider reform of the system, said a sudden change of the rules as markets collapse could raise moral hazard issues and amount to "valuation forbearance" -- allowing companies to gloss over losses on their portfolios.

He said accounting rules "should be structured so as to support best risk management and disclosure practices in both upturns and downturns."

Since the collapse of Lehman Brothers last month, uncertainty about whether a bank may be sitting on toxic investments that could leave it exposed to fatal losses has made financial institutions fearful of lending to each other.

As a result the vital system of interbank lending that keeps the financial system running has all but frozen.

"In many respects the current crisis is about valuation," Noyer noted.

WEAKNESSES

His paper said the crisis had laid bare a series of weaknesses relating to the way different accounting systems set a value on assets in bank balance sheets and thus allow the market to form a picture of a risk of default.

There has been particular criticism of the application of so-called mark-to-market rules, blamed for putting some firms in difficulty as markets have plunged.

European banks have complained that their U.S. rivals have more flexibility over the application of the rules and Sunday's move by European leaders was welcomed by the Bank of France as helping to redress the balance.

"We are very favorable to these propositions because they will allow European banks to benefit from the same flexibility as American banks enjoy," a Bank of France spokeswoman said.

Under mark-to-market or fair-value rules, companies are obliged regularly to adjust the valuation of assets they hold to reflect changes in their actual price on the market.

The rules are intended to improve transparency by preventing companies from inflating their balance sheets by setting artificially high values on the assets they hold.

But in the current crisis, where markets for many complex derivative products have disappeared or where illiquid markets have created sharp swings in prices, it is often impossible to establish a true market value for a particular asset.

Valuation rules may also have exacerbated the dramatic sell-offs seen on markets in recent weeks as financial institutions rushed to dump assets when falling markets started to squeeze their balance sheets, the paper said.

But it said alternative systems, including those based on amortized historical cost, were not necessarily better and allowed damaged assets to remain undiscovered for longer.

"In practice, financial stability may benefit from the existence of valuation and accounting rules that are more sensitive to differences in investment horizons," it concluded.