Uncertain About Confidence

Politicians and regulators assure us that a lack of confidence impairs economic recovery. However, one area of internal and external compliance remains too confident after debacles since 2007, financial statements, which were proven far too optimistic for most major financial institutions. For any significant asset, we expect seven not-so-precise pieces of evidence: cost, ownership, disclosure, value, existence, responsibility and benefit (a fishy COD-VERB). Yet despite the uncertainties, especially around value, accountants and auditors report a single, definite number, not a range. Long Finance is an initiative of several thousand financial services professionals addressing the question, “when would we know our financial system is working?” This initiative has proposed a different approach, using ranges rather than discrete values to represent key items on the profit & loss and balance sheet, Confidence Accounting.

This approach is gaining attention. Andy Haldane, Executive Director, Financial Stability at the Bank of England stated in December 2011, “For perhaps the first time, it [‘Proposed Regulatory Prudent Valuation Return’, published in December 2011] provides confidence intervals around banks’ balance sheets – what some have called “confidence accounting”. Such an approach has large implications for those of us providing financial information. First, a widespread discussion is needed, aimed at understanding the implications for management behaviour. Second, deep training is needed to move financial professionals from additive and subtractive book-keeping to more statistical approaches. Broader training is also needed among other users of accounts so they understand the new approaches. Third, using ranges rather than numbers will strain information systems, which will need to encompass Monte Carlo modelling and richer presentations as a matter of course. Fourth, Confidence Accounting provides a comprehensive way to evaluate internal and external audits – were your stated results within the confidence intervals over time? This harsh evaluation will discomfit today’s cosy auditors. The upshot? Hopefully a world more confident that compliance professionals, financial professionals and auditors are able to express their own uncertainties.

Professor Michael Mainelli, Executive Chairman of Z/Yen Group Limited, is a scientist and accountant. His book, “The Price of Fish: A New Approach to Wicked Economics and Better Decisions”, co-authored with Ian Harris, introduces Confidence Accounting.

[An edited version of this article appeared as "Uncertain about Confidence" EURO CFO Ltd, Aerial, Issue 1 (June 2012).]