When a teacher asks the class to mark their own homework, there is an element of trust there. The other aspect is that routine homework is not important. The really important exams are the public exams, graded by other teachers.
One would be quite surprised at how often government asks companies to mark their own homework. Banks’ provisioning is based on internal assumptions. A bank can opine on the probability of default of a corporate
customer, and classify it based on its own system. This gives them a lot of freedom in the expansionary part of the business cycle. Two banks with similarlevels of bad assets being reported might have completely different underlying
asset quality. The flexibility is less when the loans start going sour. Nonpayment delay can be counted without any element of judgment or skill, and when certain thresholds are crossed, such as 90 or 180 days overdue, the
bank has to reclassify the loans into buckets called doubtful/defaulted, etc.. Auditors will check if the bank is doing what it says it would do, and there are banking regulator-set rules on provisioning, as well. A bank’s rules may be
more strict than the regulator, but not more lax.
Governments may direct banks under their influence to lend to areas that may be commercially wasteful. This may not be evident in the good times. When the cycle turns, and loans see defaults, even governments cannot change
accounting standards. Then will be forced to make up for their previous meddling by being forced to add capital to the banks, or see them wind up. One way to avoid infusing capital is to just let the earnings catch-up over time, to match the (needed) expected level of provisioning. I was listening recently to a bank explaining how since it was private, it did not have to recognize their bad loans all at once (which would have made them bankrupt), but spread out their provisioning over 5 years. You cannot trust a bank’s numbers more than you trust management. When banks trade well below book value, it is not just because investors expect a bad year. It could be several bad years.