By putting the focus on balance sheets and, in particular, on identifying “troubled” assets, the Government's asset protection scheme goes to the heart of the banks' lending problems.

The scheme is designed to insure participating institutions against exposure to exceptional future credit losses. The Treasury protection will cover the majority, but not all, of the credit losses which exceed a “first loss” amount. Reaching agreement on the fair value for troubled assets in illiquid markets is a crucial step in implementing the scheme.

Transparency and trust are essential in rebuilding confidence in the banking system. International Accounting Standards Board guidance states that valuations based on management's internal assumptions that do not take into account factors such as credit and liquidity risks would not meet the objectives of fair value measurement.

Failing to write down these troubled assets to a fair value would not only lack transparency but also transfer the risk to taxpayers. Given the unprecedented losses believed to be on the banks' balance sheets, auditors should endeavour to use their best judgment when assessing fair value. Further writedowns would impair bank capital ratios even further, requiring increased government ownership.

Further immediate government initiatives are required. First, the insolvency framework will need to accommodate large companies with complex capital structures. The European High Yield Association has proposed a more orderly procedure to deal with large company restructuring, which is designed to improve recoveries on loans and corporate bonds.

Second, the FSA recently warned that 1,000 homes were being repossessed every week. Banks in which the Government has a majority stake should be encouraged to modify repayment terms on distressed mortgage assets so that people can remain in their homes. Local authorities should also consider central bank funding for the acquisition of these properties through quantitative easing.

Third, according to Standard & Poor's £140 billion of UK corporate debt will have to be refinanced between now and 2011. This should be factored into bank lending plans.

Fourth, global agreement is required in dealing with some of the causes of the financial instability. Enhancements to the Basel II regulations to improve the framework for risk assessment and capital requirements are under discussion. The focus on short-termism, lack of transparency and pro-cyclicality of the regulatory framework should also be agenda items at April's G20 meeting.

Priority must be given to agreeing a fair value for the troubled assets to avoid transferring the uncertainty and mistrust to the nation's books.

— Francis Richard Pereira is an actuary and chartered accountant specialising in fixed income and credit markets.

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