International finance : the impact of the G-SIB designation on audit fees and financial reporting for banks
08/22/2024
4 min
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The Global Financial Crisis of 2007-2008 highlighted the systemic risks posed by large, interconnected banks, prompting a series of regulatory reforms to enhance the stability of the financial system. To reduce the inherent problems caused by banks being considered “too big to fail”, the Financial Stability Board (FSB) has published an annual list of global systemically important banks (G–SIBs) since 2011. These banks have been subject to stricter supervision since then and to regulatory capital surcharges since 2016. The latest list from November 2023 comprises 29 banks from around the world.
A new *study investigates the impact of the G-SIB designation on audit fees and financial reporting quality (FRQ) among European banks. Indeed, closer supervision and/or anticipated capital surcharges for G-SIBs may alter auditors’ engagement risk and effort, for instance, through higher litigation risks.
Stability of the international financial system
In the wake of the financial crisis, the FSB and Basel Committee on Banking Supervision (BCBS) introduced a series of measures aimed at curbing excessive risk-taking and enhancing the overall stability of the international financial system. Auditors can play a critical role in fulfilling financial stability objectives by better assessing the financial health and risk profiles of banks. Indeed, improved transparency of financial accounts can enhance the market discipline of banks’ risk-taking decisions.
The study by researchers from IÉSEG, HEC Lausanne (Switzerland) and the Bauer College of Business (US) has analyzed the impact of the G-SIB designation, notably in terms of audit fees.
Their study utilizes a sample of 183 European banks from OECD European Union countries (15 countries in total), covering the period 2007 to 2014.
G-SIB designation led to rise in audit fees
The researchers found that the G-SIB designation led to a significant 12.8% increase in audit fees compared to non-GSIBs.
Furthermore, the researchers showed that the increase in audit fees was more pronounced in countries that relatively had less powerful supervisory bodies just before the G-SIB designation. Examples included Spain, Sweden, and the United Kingdom.
Supervisors in those countries, who were relatively less powerful at the time of the GSIB designation, were arguably granted more power by the regulation, compelling auditors to exert more effort and justify higher fees. “This result indicates that auditors reacted mostly to closer banking supervision rather than to potential agency problems driven by anticipated regulatory capital surcharges.” explains Professor Romain OBERSON from IÉSEG, one of the co-authors of the study.
The third main finding of the study relates to the quality of financial reporting: the higher audit fees reported were associated with improved financial reporting quality. The researchers used two measures to assess financial reporting quality: “income smoothing” and “abnormal loan loss provisions”.
Income smoothing refers to an accounting technique used to reduce fluctuations in earnings, presenting a more stable financial performance over time. Abnormal loan loss provisions refers to provisioning levels that deviate significantly from what is typically expected based on the quality of bank’s loan portfolio and prevailing economic conditions. The researchers suggest that this last finding indicates that the reported increase in audit fees is more likely to reflect higher audit effort rather than solely reflecting a higher risk premium charged by auditors due to higher litigation risks implied by closer banking supervision.
Applications for policymakers and G-SIBs
Overall, this study sheds light on the interplay between auditors and banking supervisors who, despite their overlapping roles, pursue distinct objectives. The researchers note that their findings highlight that the enhancement of the capabilities of banking supervisors by policymakers has significant economic consequences on the auditor-client contracting equilibrium. While closer banking supervision translates into higher audit fees and thus additional costs for these banks, it contributes to better financial reporting quality as well. Policymakers can therefore look to balance regulatory burdens with tangible benefits in bank transparency.
The findings of the study highlight that G-SIBs should not only anticipate closer banking supervision but also higher levels of audit fees, reflecting higher audit scrutiny. They should allocate resources accordingly to ensure compliance and target high financial reporting quality.
“The designation of banks as G-SIBs in 2011 by the FSB brought about significant regulatory changes aimed at enhancing financial stability. Our study finds that the G-SIB designation leads to higher audit fees and improved financial reporting quality, particularly in countries with weaker banking supervisors prior to the G-SIB designation. This is consistent with the idea that closer banking supervision impacts auditors’ work” concludes Professor OBERSON. “It is important that stakeholders – the banks, auditors and policymakers – are aware of this twin impact in terms of financial costs and benefits.”
*Lobo, G. J., Oberson, R., & Schatt, A. (2024). European Global Systemically Important Banks, Banking Supervisory Power, and Audit Fees. European Accounting Review, 1–26.
