Spanish Bank Crisis – Were the Auditors Asleep on the Job?


There is much in the news today about various firms of auditors being appointed to analyse the real bad debt situation that has caused the banking crisis. As a small scale Spanish auditor myself, I can’t help think that something has gone seriously wrong in the audit profession in Spain and it amazes me that no one is pointing the finger at the big firms that have been responsible for the audit of the Spanish banks in recent years. Amazingly, it is the same firms that are now being appointed to carry out a new review of the bank’s balance sheets.

Let’s face it; these bad debts didn’t arise overnight.

They have been fermenting for years.

Apart from a few blogs in the US about the performance of US auditors in the run up to the Lehman banking crisis, I have found nothing in my googling that even raises the issue of the performance of the auditors in relation to Spanish banks.

The fundamental role of auditors is to ensure that the financial statements that a company presents to its shareholders are a true and fair reflection of the company’s financial situation and that the fundamental accounting concepts and relevant accounting regulations have been faithfully followed in preparing the financial statements.

Amongst the age old concepts that should be applied in financial statements is prudence. Rather than bore reader with the detail, this concept means quite simply that when valuing assets a company should exercise prudence and reduce the value of assets when it is not certain that they will be fully recovered, i.e. turn into cash. I found this detailed explanation for those that want to know more, but the idea, like most good ones is obvious and simple (

In effect, when the auditor expresses his opinion in his audit report, and this forms an integral part of the financial statements that are presented to the shareholders and the public, he is saying that he agrees with the company’s management that the value of the debtors (amongst many other assets) makes adequate allowance for those debtors who will not pay up in full. In other words the auditor is stating that the provision for bad debts is reasonable.

In the balance sheets of banks this is obviously one of the most important balances because one of the main roles of banks is to lend money (Well it was. I’m not sure what use they are these days!).

This takes me back to a technical course I attended a few years ago in Málaga as part of my routine ‘continuing professional development’. I was chatting over coffee during a break (regular coffee breaks being essential to avoid dozing off during these seminars) with my fellow professionals and the course speaker. At that time, there had been much in the news concerning the plight of developers and the 1,200,000 odd unsold new apartments in Spain. I hasten to add that all the course attendees came from small firms of auditors and none had large developer clients, let alone banks, as clients.

I raised the question about how it was that the massive unsold stock of apartments in Spain, and the obvious fact that the properties were not selling at book prices, had not resulted in provisions reducing the value of stock to prices that the market would actually be willing to pay. I made the point that people (this was at a time that there was still some money about in Spain) would be willing to buy if the price was right. I mentioned that an across the board discount of 50% would probably do the trick and attract a host of foreign investors.

This question seemed to cause some consternation.

I added that if the developers’ balance sheets reflected real market values then most of the developers would go bust and the banks that had lent them up to 100% of the building costs would go bust too.

There was a lot of shifting from one foot to the other amongst my audience, and sideways glancing and clearing of throats.

Ah but… ahumph… ‘You can’t do that, it wouldn’t be right…’ ‘You have to value stock at cost and the developers do manage to sell a property now and then at the list price’.

In other words, it was generally understood that the whole edifice of the Spanish property development industry, and the banks with it, would collapse like a pack of cards if the ‘prudent’ accounting concept was strictly adopted.

I jested ‘these odd property sales, are you sure that they are not selling these properties to ‘friendly’ buyers?’. By this I surmised that the developers might cook up buyers near the end of the year to make sure that the auditor couldn’t say that the stock was overvalued.

There was some laughter (auditors do make jokes, now and then) and the subject was quickly changed to something deeply interesting, like the accruals concept.

The point of this little story is that the Spanish audit profession, like everyone in authority in the property development and banking sectors knew that it was on shaky ground.

And no one wanted to upset the applecart.

The Banco Financiero y de Ahorros (BFA) was born in December 2010 with the merger of seven Cajas that were in trouble. In April 2011 the operations of the Cajas were hived off to a new 100% owned subsidiary and BFA kept the toxic assets it inherited from the Cajas. Bankia is now the 4th largest bank in Spain. Bankia was launched on the Madrid stock exchange in July 2011 and attracted 3.5 billion Euros in share sales. BFA’s investment in Bankia stood in its balance sheet at 8.5 billion Euros.

Disaster struck a few weeks ago which caused the Government to effectively nationalise Bankia.

This happened because Deloitte, the auditor of BFA refused to sign its accounts for two reasons, at least according to press commentary:

  1. BFA’s balance sheet showed its interests in Bankia as an asset worth 12 Billion Euros whereas the cost of the investment was actually 8.5 Billion. At the time, the stock market valuation of the investment was valued as low as 2 billion Euros signifying a potential loss or BFA of 10 Billion Euros.
  2. BFA’s balance sheet treated as an asset of 2.5 Billion Euros something weird and whacky called ‘deferred tax credits’. This type of balance arises when a company makes a loss and will be able to use that loss to offset future taxable profits, thereby saving corporation tax in future years. In other words the board of directors of BFA thought it ‘prudent’ to treat future tax savings as an asset today. Now that would be fine and dandy if the board could be certain of making a substantial profit in the near future but, remember we are dealing with a bank that has, almost certainly, not made ‘prudent’ allowance for its bad debt.

In respect of the Bankia mess, well done Delloite and about time, I say, but what could possibly have happened in only 10 months? How could shares of Bankia have been sold to the unsuspecting public? What about the bad debt provisions that must have been needed in 2009, 2010 and 2011?

Incidentally, readers will be curious to know that the management boards of the Spanish Cajas were made up almost entirely by politicians because they were community owned, not for profit organisations intended to benefit the communities they served.

Fertile ground, I think, for the conspiracy theorists. What has been going on in Spain between the developers, the banks, the Government, the Bank of Spain and the CNMV (stock exchange supervisor)?

It seems clear to me that ‘hope‘ was adopted as the main accounting concept. Hope that it would all turn out OK in due course. All that was needed was to keep quiet about the bad debts exposure for a few years until the financial crisis elsewhere had resolved itself and the markets would normalise.

It is a pity that the Euro, Greece and the sovereign debt crises have got in the way.

What is truly frightening is that the same consultants/auditors are now being commissioned to review the Spanish banking system’s provisions for bad debts. One of them, Oliver Wyman, is quoted as saying in 2006 that Allied Irish is the world’s best bank! See

Allied Irish went bust too.

We all now know that until 2008 in Spain there was frenzy over property values but in 2010 and 2011 there was no excuse. Where were the prudent provisions for bad debts.

Alistair Spence Clarke 22 May 2012

PS: I thought it would add a little context to add this article with a few choice items in today’s news:

Carlos Dívar, the president of the General Council of Judicial Power and supreme court in Spain was excused from prosecution today in relation to the alleged fraudulent use of public funds in that he had received reimbursement of travelling and hotel expenses for 20 four day weekend visits to Marbella costing the public purse some 20,000€. This constitutional body oversees judicial independence in Spain and proudly announces in its website “Justice at your service”. The press reports that the use of public funds has not been denied and questions what possible work in Marbella could possibly justify the claiming of these expenses. The state prosecution office is reported as saying “no evidence exists whatsoever, direct or indirectly, that permits affirmation that the conduct of the president …. should be submitted to the parameters of criminal law”.

José Luis Olivas, the president of Bancaja, one of the subsidiary banks of Bankia which was nationalized a few weeks ago has resigned. His temporary replacement is Antonio Tirado, who is currently a vice president of Bancaja. The press has expressed consternation at this appointment given that Sr Tirado has been indicted and is currently being investigated for false accounting, fraudulent management and falsification of company documents in relation to his management of Banco de Valencia, another bank that has been taken over by the Spanish Government.

Honestly, you couldn’t make it up. I feel that I am living in another dimension!

Spence Clarke specialises in the provision of Spanish tax, accounts, law and labour services, mainly to foreigners with interests in Spain. Our cross-border knowledge helps clients adapt to the Spanish system with the minimum of doubt and disruption. If you have any questions about this article or any other matter contact us, with no obligation, to see how we can help you.