UK accounting watchdog warns over bank audits

* Bank loan-loss provisioning an accounting concern

* Watchdog says broader review must bring improvements

* FRC to consult on new transparency rule

By Huw Jones

LONDON, May 28 (Reuters) - Accountants who check the booksof Britain's banks must sharpen their act or could be ordered totake corrective measures, the sector's watchdog said in a reportshowing how a core lesson from the financial crisis has yet tobe applied.

The Financial Reporting Council (FRC) said in its annualaudit quality inspections report that there was a significantimprovement in audits of listed companies in general, but thebanking sector continued to lag.

"The overall grading of bank and building society audits is,and continues to be, generally below those of other types ofentity," the FRC said.

The inspections during 2013 and 2014 covered audits for theyear that ended December 2012. They included the books of fivebanks and five building societies, all unnamed and none were"good" - the top grading - while 56 percent needed improvements.

In particular there was no significant improvement in howaccountants check the way banks set aside capital to coversouring loans, known as loan-loss provisioning.

Too low levels of capital forced taxpayers to shore uplenders during the 2007-09 financial crisis. It also promptedpolicymakers to ask auditors why they gave banks a clean bill ofhealth just months before they had to be rescued.

"Weaknesses in the testing of loan impairment models andrelated assumptions were key issues," the FRC said in thereport.

"Insufficient challenge of management or the failure toobtain further evidence to support provisioning judgements werecommon themes in the issues identified."

Britain's competition watchdog and the European Union arebringing in rules forcing companies to change accountants morefrequently to avoid cozy relationships and failure byaccountants to question what they are told by customers.

Paul George, the FRC's executive director for conduct, islooking for a "step change" in audit quality at banks when theFRC publishes the results of a separate broad review of bankbook-keeping in the autumn.

"If we do not see the level of progress that we expect thenclearly enforcement would be something we would need toconsider," George told Reuters.

The FRC announced the separate review of 13 banking auditsin December in a bid to focus the minds of auditors as theychecked banks' financial statements for 2013.

It came after routine inspections by the FRC were notproviding "sufficient incentives" for accountants to improvetheir work at banks.

"The headline message is that the firms took our concerns inDecember 2013 very seriously and have sought to take actions toaddress those points but it is too early to assess whether thoseactions have been effective," George said.

The FRC does not name the banks and other firms whoseaccounts it reviews annually but this could change.

Britain's competition watchdog has recommended that auditcommittees at companies say if the FRC has inspected theaccounts and what the outcome is.

George said the FRC supports transparency and will launch apublic consultation later this year on how audit committeesmight report to shareholders on accounting concerns. (Reporting by Huw Jones; Editing by Susan Fenton)