The Role of Accounting in the Collapse or Failure of Caja Mediterrneo Bank - Essay Example

The role of accounting in the collapse or failure of Caja Mediterraneo (Cam) Bank CAM bank has been a recognized financial institution in Spain, which has been serving a large customer base, to the extent of being classified as the fourth largest savings bank in Spain, by the year 2007 (manta 2012, Web). However, the trend has now changed making the bank collapse. While there are many questions that linger regarding the causes of this collapse, it is apparent that accounting practices, both legal and illegal played a major role in making the Bank collapse. However, the most cited reason for the collapse of the bank is the application of Creative accounting by the top management of the bank, seeking to serve their own interests and deny the general public an opportunity to get a true glimpse of the nature of the bank’s financial situation (ANCODEESPANA 2012, p7). This has led to the recent CEOs of the bank being removed from their position, owing to the culpability in the accounting irregularity. In addition to the contributions of the top management in the collapse of the CAM Bank, the auditors of the bank’s books of accounts participated in the same questionable practices, since they did not raise any question to the discrepancies realizable in the accounting statement of the Bank, despite there being sufficient grounds to indicate such discrepancies (Penty 2011, Web). Therefore, the collapse of the CAM bank can be traced to accounting practices, and thus this discussion seeks to investigate the role of accounting in the collapse or failure of Caja Mediterraneo (Cam) Bank, with a view to understanding the specific accounting concepts that were applied. The role of accounting in the failure of the CAM Bank can be traced in the accounting concept of creative accounting, where loans to directors were offered at low rates and bonuses (IMF Country Report 2012, p22). While CAM Bank is a non-profit financial institution offering retail banking service to the customers, especially individuals and SMEs, it is also mandated to offer loans and mortgages to its customers, especially for house and home property development (Anon 2011, Web). Nevertheless, while there are standards and policies guiding the issuance of loans to the customers of the bank, including the banks own employees, for mortgage or property purchasing purposes, the directors had adopted a different illegal parallel-policy formulation, which allowed the loans to directors at low rates and bonuses, thus saving them the payment of the due mortgage or loam payment rates (Cook & Pond, 2006 p22). This served to make the financial situation of the Bank worsen, to the extent that the bank had lost 1.7 billion in the first nine months of the year 2011, while also incurring the bad loans ratio to the tune of 28.3% (manta 2012, Web). This practice has worsened the financial situation of the CAM bank, to the extent that it has become impossible for the bank to continue its operations on its own, and thus has to be operated under the control of The Bank of Spain, while also having more funds channeled to the bank, to ensure that it can revive its operations (Bjork 2011, C3). Boosting the balance sheet is yet another accounting concept that has been adopted by the top management of the CAM Bank, to ensure the falsification of its financial records, and thus improve the image of its financial performance, while in reality the situation was worse (Spain's central bank favors merger of Caja Madrid’ 2010, Web). Balance sheet boosting is an accounting concept that is applied by companies and other organizations to project a strong financial condition currently, and give an indication of future financial prosperity of the business organization. The top management of CAM bank applied this accounting technique to inflate the financial accounts of the Bank, through inflating the accounting receivables and thus projecting a financial situation where the bank is likely to receive more incomes, while in the real sense the Bank was running at an all-time high debts owed to its customers who it had sold its shares (Cook & Pond, 2006 p47). Through the application of the technique, CAM bank top management was able to post 40 million Euros profit for the Month of March, as the profit for the first quarter of the year 2011 (Egan, 2012 p21). This served to indicate to the public that the Bank was in a good financial position, and thus gave the customers the much desired confidence to continue trading with the bank, only to realize that the bank had actually lost to a tune of 1.7 billion Euros in loans, while its bad debts had increased significantly by the September of the same year (manta 2012, Web). Thus, balance Sheet boosting is an accounting concept that was applied by CAM bank top management, to drive it towards its collapse. Open fraud is a major aspect of accounting that played a role in the collapse of CAM Bank. The collapse of the bank was preceded by the a massive loss of customer base in the whole country from where it had a wide spread customer base, but the effect was highly felt in two major provinces of Murcia and Alicante, where the bank had a huge customer base (Anon 2011, Web). The open fraud was perpetuated in the form of the bank taking insurance premiums from the customer in relation to the property the Bank had assisted the customers to purchase from its mortgage and loan offering, and then refusing to compensate its customers for the damage and loss of the insured property, whenever such occurrences were registered (Penty 2011, Web). The bank acted as a mediator between its customers and the insurance companies, and thus the insurance companies deposited the amounted it owed for compensation to the customers in the bank, so that the bank could pass the same to its customers (Graham, 2002 p97). However, it was discovered that many legal litigations were being filed against the bank for receiving insurance compensations from the insurance companies in favor of its clients, and failing to pass the same to the property owner (Anon 2011, Web). Thus, open theft and open-fraud is one of the accounting concepts that was applied by the Bank to swindle its customers, which eventually led to the loss of its customer base and the consequent lack of sufficient revenues to run the bank, which ultimately led to its collapse. More than any other accounting irregularity, claims falsification and pension-inflating played a major role in the collapse of the CAM Bank. The CEOs of the CAM bank had adopted an accounting concept of inflating their pension compensation, upon their vacation from office. The pension compensation claimed by the previous two CEOs of the Bank proved to be disproportionate with the salaries and the duration they had served in the institution. Maria Dolores Amoros, the latest CEO of the bank, who literally brought the bank to its knees financially, had claimed a pension compensation of 370,000 Euros (Kandell 2011, Web). This is despite the fact that she had only served in the bank for a meager period of two months only. This claim surpassed proportionality by all standards, notwithstanding the fact that she had been relieved of her duties due to the accounting irregularities she had overseen happen in the Bank, which eventually led to the collapse of the Bank. While serving her last month in the Bank, she was only earning half her salary, without any other form of CEO bonuses, since the Fund for Orderly Bank Restructuring (FROB) had launched an inquiry into her conduct, necessitating her salary cut by half, and the consequent removal of the CEO bonuses from her pay check. Therefore, the claim for 370,000 Euros could not have been realizable, owing to only two months’ salary, of which one month’s salary was halved and without any bonuses. This was not the first scandal of its kind in this bank. The predecessor of the Maria Dolores Amoros as the CEO of the CAM bank had also been involved in a similar falsification of claims and pension inflating. Roberto Lopez Abad was the predecessor of Maria in this office, who was receiving an annual salary of 700,000 Euros (manta 2012, Web). However, upon his exit from the office, the CEO lodged a claim of 3 million Euros as the compensation for pension, for the duration he had served in the bank. This is yet another example of the disproportionate pension claims that the top management of the CAM bank were making on the banks accounts, rendering the Bank incapable to commit its finances to other reproductive areas and thus unable to meet the needs of the customers. This practice highly contributed to the collapse of the bank. It is these accounting irregularities that have seen both Roberto Lopez Abad and Maria Dolores Amoros lose their positions as the CEOs of the CAM Bank, considering that their activities have swindled the bank a substantial amount of its resources, making it unable to address the customer needs or discharge its financial responsibilities to the customers (ANCODEESPANA 2012, p3). Accordingly, FROB has fired these banks administrators and hired new ones, to take charge of the bank after more funds are channeled to the bank, to enable it continue with its operation, while under the control of The Bank of Spain. Undervaluing liabilities is a role that was played by accounting in the collapse and failure of Caja Mediterraneo (Cam) Bank. Most especially, CAM Bank applied the concept of contingent liabilities undervaluing, to project that its debts owed to the public and to other financial institutions were not substantial to affect its operations and profitability (ANCODEESPANA 2012, p10). The top management underestimated the value and impacts of the legal litigations raised by the customers against the bank in its financial reporting, which played the role of making the legal obligation of the Bank appears to be unsubstantial to the operations of the bank. Additionally, the other aspect of account falsification by the bank that was applied is the undervaluation of the debts owed by the bank to its customers and its lenders, to whom it had offered a sale of its shares in the Initial Public Offer (IPO), which ranked CAM as the first Spanish Savings bank to issue shares to the public, and which also ranked its offer as the largest IPO for the year 2008, on Madrid Stock Exchange (House 2011, Web). The application of this accounting practice served to understate the liabilities of the CAM bank, while on the other hand forcing the financial statements to overstate the net income of the Bank, and thus falsify the shareholders’ equity value, by inflating it (Marshall 2002, p25). All these was meant to give the share holders an impression of a financially sound and stable financial institutions, while in the real sense, the bank was on the verge of collapse, owing to the huge losses and the bad debts it had incurred. Works Cited ANCODEESPANA 2012, Report to the executive committee Proposing the initiation of disciplinary proceedings, Madrid: Caja de Ahorros del Mediterraneo. Anon. 2011, Banc Sabadell buys Caja de Ahorros del Mediterraneo (CAM) for just €1 after a successful regularisation process, CNA, 7 Dec. Available at: http://www.catalannewsagency.com/news/business/banc-sabadell-buys-caja-de-ahorros-del-mediterraneo-cam-just-%E2%82%AC1-after-successful-regul. Anon. 2011, Caja de Ahorros del Mediterraneo’s Stake In Banco Cam SAU Drops Down To Zero; Announces General Reaorganization, Reuters, 15 Dec. Available at: http://www.reuters.com/finance/stocks/CAHM.MC/key-developments/article/2451698. Bjork, C. 2011, Global Finance: Bank-Sale Pain for Spain, New York, N.Y., United States, New York, N.Y.: C3. Caja Mediterraneo and Accenture Deploy Alnova Core Banking Platform 2010, New York, United States, New York, Available at http://search.proquest.com/docview/760003552/13BF9B9F95F52CE4963/1?accountid=45049 Cook, G. & Pond, K. 2006, "Explaining the choice between alternative insolvency regimes for troubled companies in the UK and Sweden,” European Journal of Law and Economics, vol. 22, no. 1, pp. 21-47. Egan, M.E. 2012, "Holding Pattern,” Legal Week, vol. 14, no. 31, pp. 20-23. Graham, D. 2002, "A dark and neglected subject: landmarks in the reform of English insolvency law", International Insolvency Review, vol. 11, no. 2, pp. 97-97. House, J. 2011, Bank of Spain to Take Over CAM, New York, N.Y., United States, New York, N.Y. Available at http://search.proquest.com/docview/878781708/13BF9BAB2295CCB8B10/1?accountid=45049 IMF Country Report 2012, Spain: Safety Net, Bank Resolution, and Crisis Management Framework—Technical Note, Madrid: International Monetary Fund. Kandell, J. 2011, "Can Spain's New Government Clean Up The Country's Banks?", Institutional Investor, Available at http://search.proquest.com/business/docview/993118367/13BF7167A73573142F9/3?accountid=45049 Marshall, J. 2002, "Comparing Europe's insolvency rules", International Financial Law Review, vol. 21, no. 6, pp. 23-30. Spain's central bank favours merger of Caja Madrid, CAM, 3rd partner 2010, London, United Kingdom, London. Available at http://search.proquest.com/business/docview/366932018/13BF715C7DC4148EF60/6?accountid=45049 manta 2012, Caja De Ahorros Del Mediterraneo, [Online] Available at: http://www.manta.com/c/mm01cyq/caja-de-ahorros-del-mediterraneo [Accessed 1 Feb 2013]. Penty, C. 2011, Spanish Caja Merger Collapse May Scare Off Potential Investors. Bloomberg, 1 April, Available at: http://www.bloomberg.com/news/2011-03-31/spanish-caja-merger-collapse-may-scare-off-potential-investors.html. Read More