Of bank annual reports, awards and their public policy implications
By Joan de Zilva Moonesinghe
“DFCC Bank releases concise annual report” – At long last, sanity seems to have prevailed in the published accounts of banks in one financial institution at least and my hallelujahs to the DFCC for courageously setting the trend in this regard and being bold and different but still beautiful!
With bank annual reports having developed over the years into monolithic volumes of over 300 to 450 pages, one often wondered what all the information frenzy was about. However, leafing laboriously through these bulky reports with their glossy covers, one of them even portraying a danseuse on its cover, it was almost three quarters down the way that one could finally locate the actual financial statements and the notes to the accounts, which invariably were relegated to the end of the report. This has strangely become accepted best practice for reasons that, to me, defy common-sense reasoning.
In my mind a bank annual report – much awaited eagerly by shareholders, depositors, investors and other stakeholders – was fundamentally the presentation, for public consumption, of its annual financial performance during the financial year, relative to how it performed the previous year, adequately supported by the explanatory notes to the accounts. The financial highlights of its performance during the year, followed by the Chairman’s and the CEO’s statements, preceded the financial statements.
This simple format was, up to almost a decade ago, the essence of a bank annual report and had, perforce, to take precedence over all other ancillary comments or discussions emanating therefrom.
I am not sure when and how this format changed to embrace what is today commonly referred to as almost a slavish adherence to GRI guidelines and its offshoot, G4, where sustainability reporting has become ‘de rigeur’ in bank annual reports, so much so that it digresses significantly from the essence of a bank annual report which is, basically, an assurance of its financial soundness. Isn’t this what the lay public and indeed the financial savvy are eager to know? So then why change course so significantly with copious commentaries from various committees, etc. on the operational aspects of the bank’s internal processes, with a lot of, what seems to me, is a tick box checklist on sustainability and corporate governance and what is in vogue currently, on ‘integrated reporting’?
Comprehensive details on the regulatory directions governing CG and the G4 guidelines on sustainability are listed and the bank’s compliance is ticked off with a cross reference to relevant parts of the report. I have still to see any non-compliance reported in any of these reports. With such a high level of CG and sustainability compliance standards, would it not make more sense to summarise these subjects in a well-articulated commentary on the CG culture at the bank and where there were any remissions, if any, to identify them and explain the action taken to remedy these gaps?
To quote from Mervyn King, the former Governor of the Bank of England and Chair Emeritus at the Global Reporting Initiative (GRI), in the plenary session launching G4 – the Sustainability Reporting Guidelines – He said, Hellen Keller once quipped, “There’s something worse than being blind – it’s having sight but no vision.”
It is reported as a common criticism of GRI and the GRI guidelines that the focus is on more reporting, not better reporting or more usable or actionable reporting. GRI’s focus has been to continually get governments and stock exchanges to require more organisations around the world to produce sustainability reports, preferably with using the GRI guidelines. The focus on quantity over quality, supports the value of GRI’s brand but has also resulted in many reports that are little more than public relations efforts.
Of particular concern is GRI’s handling of the reporting principle known as sustainability context, without which there can be no bona fide sustainability reporting at all. By choosing to leave that principle in its prior state of disrepair, GRI has effectively consigned organisations to another five or six years of feckless reporting, and itself to irrelevance.
As GRI has been pointing out for over a decade now, corporate sustainability reports must be inclusive of sustainability context to be meaningful. Environmental impacts should be reported relative to ecological thresholds, and social impacts relative to human needs… There simply cannot be any true, authentic, or empirical disclosure of sustainability performance unless such context is included; any more than there can be financial reporting without expenses being included.
The criticisms quoted above therefore beg the question – where is the context of sustainability in Bank financial reports. If indeed there is context, it should be highlighted, for instance if the bank is financing environmental damaging projects, etc. This could more easily be identified as responsible banking, not necessarily sustainability in its known context.
This is how the Monetary Authority of Singapore looks at sustainability reporting – guidelines issued to banks on responsible banking which makes sense. Come to think of it – does responsible banking need a ‘dictat’ from the regulator? Is this not an essential measure of good corporate governance? Obviously not, as it has had to be mandated by the regulator. So be it.
Therefore to devote pages and pages to sustainability reporting in bank reports where it is out of context, is to me, to deviate fundamentally from the only true measure of bank sustainability which is its financial soundness for the long term.
If we need to get on board the bandwagon, like we are always wont to do, like in the case of the Basle capital dogmas I, II and III, IFRS, integrated reporting, and God knows what else, please do so, but make it relevant and in context. And just as the DFCC has, in its common-sense approach to the subject, done, make these ancillary reports available to those who want to access them, in separate missives. This would make the financial report truly representative of the financial performance of the bank, focusing on the Key Performance IndicatorsKPIs) and the financial soundness indicators and, indeed, on the key business units of the bank which generate these indicators.
It is important that the financial reports must remain relevant. Even though they give the reader, primarily, a view of the past, it is a very relevant view. The problem, as I can see it, is with the nonfinancial reporting that increasingly seems to take precedence over the former and which consists mostly of box-ticking in the name of sustainability reporting, integrated reporting, corporate governance, etc. However, rarely does any of this convey a coherent story that makes sense which leads inevitably to a lot of disparate information.
It is widely recognised that an annual report is the most important single piece of information not only externally, but also internally. It is a powerful tool to communicate a company’s strengths and strategies to key stakeholders. More than just a snapshot of a company’s performance for the past year, the annual report is an opportunity to highlight a company’s key achievements, expectations for the coming year and overall goals and objectives. Using a combination of compelling visuals and eloquent and lucid text, the annual report must be able to tell a compelling story of its achievements and its growth prospects and most profoundly, its commitment to long-term financial sustainability.
A read of the annual reports of the big four domestic banks in Singapore will reveal how focused they are on their financial performance to the near exclusion of all other ancillary reporting. As a result they are not more than 250 pages in volume although they have a balance sheet size of much greater proportions and operate in a more vibrant and sophisticated financial system.
The Central Bank of Sri Lanka too would do well to take a closer look at the quality of financial reports put out by the banks and of the non-bank financial institutions under their purview, so as to ensure that all this ancillary reporting does not digress fundamentally from the more prudent disclosures required to be made on the key financial soundness indicators, particularly on asset quality and NPA, where the quality of disclosure leaves much to be desired.
It is observed that the key performance indicators over a ten year summary, a standard annexure to the report, does not disclose the NPA ratio in most of the reports. So one wonders whether those who have responsibility for structuring these reports are aware of what signifies a KPI of a bank particularly where the NPA ratio is a critical indicator of the extent to which the capital of the bank is at risk and is used productively.
The obvious pre-occupation with GRI, G4, integrated reporting and corporate governance, in my mind leaves little room for the more qualitative reporting on the key fundamentals of financial soundness, which underscores a bank AR.
With the frenzy to meet the publication deadlines too and invariably the competition that goes with it to be the first out there in publishing, it is very easy to lose sight of the key message of a bank AR – a qualitative analysis of the bank’s performance during the financial year with the emphasis on full disclosure of mandatory as well as voluntary information on the risk exposures, if any, and how they are managed and mitigated. This is the assurance that all readers would want to see to assuage any misconceptions they may have in their own interpretation of the numbers, or as a result of market talk.
The risk management report is thus one of the more important commentaries in a bank AR and while banks invariably devote a lot of attention to this subject, it is tantamount to an explanation of what the risk denotes, and the checks and balances in place to manage the risk. However, I have rarely seen a bank actually identify their exposure to these risks, which they most often have, even though not material, quantify and measure them and illustrate what measures they have taken to mitigate such risks and contain them.
It is therefore my considered opinion that if banks were not obliged, for the sake of awards, to measure up to external pressure on meeting various guidelines et al, they would have much more time at their disposal to look behind the numbers presented in the AR and to provide the critical information needed to support the adverse, or favourable, movement or trend over the previous years.
For example, there have been instances where thanks to IFRS, certain banks have been able to reverse the impairment provisions made based on CBSL directions and boost profitability. Is it not the responsibility of the bank concerned, adequately supported by a statement from the auditors as well, to be transparent about the arbitrage opportunity they have availed of as a result and justify such a reversal, so as to support the integrity of the enhanced profit they have been able to post as a consequence?
I have still to see this adequately represented in any bank AR so far and this is more so in certain non-bank financial institutions where thanks to IFRS, weak, loss-making companies have miraculously transformed themselves into profitability in just one year – and that too not marginally, but significantly profitable. In publishing their accounts, there have not been any explanatory notes on how this transformation took place.
With no policy statement from the regulators on IFRS accounting vs. CBSL mandatory requirements on impairment accounting, it is expected that the CBSL’s mandatory requirements would still remain the minimum. However, this does not seem to be the case with institutions being able to manoeuvre through IFRS and CBSL directives at their will and pleasure.
On the other hand there have been the stronger, well-managed institutions which have chosen not to take advantage of the arbitrage opportunities available and which have adopted the more prudent regulatory requirements. So there is no level playing field with regard to disclosure of operational results of these financial institutions which renders a comparative analysis futile and meaningless.
In conclusion, for institutions with fiduciary responsibility for public deposits, the integrity of their accounts and indeed of their annual results, should be the focus of any bank AR and in our attempt to get on board the bandwagons, we must not lose sight of this key objective.
Annual report and other corporate awards
With preparations afoot for the 53rd Annual Reports Awards competition, it is indeed heartening to note the assurance of CA Sri Lanka to ensure the highest standards of transparency and accountability in the awards competition. In its commitment to ensure its independence and objectivity, it would be useful to give due consideration to the matters discussed above, particularly with regard to the annual reports of financial institutions with fiduciary responsibility, which distinguishes them from other corporates.
It would be prudent to ensure a requirement that a regulatory sign-off on compliance with the key prudential ratios, be an essential pre-requisite for such an award for licensed, deposit-taking financial institutions. In this regard, it should be noted that mere representation on the panel, from the Central Bank of Sri Lanka as the regulator, would not constitute a sign-off.
External awarding agencies
It should be appreciated that the credibility of the whole annual reports awards process is at stake if the hallowed tenets of transparency, accountability and good governance are not upheld. Apart from CA Sri Lanka, whose credentials are well known and accepted, it would be useful to have some sort of disclosure of the numerous external awarding agencies, especially where it has become so commonplace to see awards being granted to various institutions and to corporate persons as well, for so-called corporate achievements.
In the interests of the integrity of the whole awards granting process, and the independence of the awarding agency, their credentials, the criteria used, the selection process and whether, indeed, there has been any monetary benefit to the awarding agency from the whole process – such information should be made available to the public.
At the rate and speed at which the corporate awards bandwagon is rolling, I am sure there are few corporates who can claim that they have not received an award so far. This makes the whole awards process more mundane than prestigious and if not proved otherwise, would appear to be available to the highest bidder!