However, in many developing countries, an accounting and auditing tradition is lacking. There may be a shortage of skilled practitioners and, frequently, a professional accounting body does not exist. In addition, accounting and auditing systems and financial disclosure may be nonexistent. The effect is to hinder the development of a well-functioning financial system.

A major weakness in bank accounting and auditing for many developing countries is the absence of adequate accounting standards. Criteria for determining nonperforming assets is subjective, problem assets are not identified or properly valued, interest continues to accrue on nonperforming assets and in many cases it is capitalized or refinanced, and foreign exchange or other losses go unrecognized. These practices lead to inflated profits and overstated balance sheets, often hiding technical insolvency. Dividend payout often drives reported income, and banks manage their loan loss provisions and write-offs to achieve desired levels of profitability. Thus, the essential link between portfolio quality and the level of loan loss provisions is missing.

In some countries, banks may operate without the benefit of a uniform chart of accounts, consistent terminology, and standard accounting methodology. Charts of accounts often vary in structure and terminology, and the accounting principles used to determine account entries and classification are inconsistent from bank to bank. These weaknesses create distortions that make analysis and comparison difficult.

The absence of an accounting and auditing tradition extends beyond banking however. Credit is extended to borrowers without the benefit of current and reliable financial information. The lack of current and satisfactory financial information contributes to the perpetuation of collateral based lending since lenders are not able to appraise a borrower's ability to repay.

Financial disclosures made by banks and enterprises are often misleading and sometimes fraudulent. The lack of reliable financial information inhibits foreign investment and the growth of the capital markets. In the absence of reliable financial information, investors are simply reluctant to place their funds at risk.

To deal with these problems, accounting standards and the auditing profession must be strengthened. Standards that should be established include guidelines for asset classification, definitions for past dues and nonperforming assets, prohibitions against the capitalization or refinancing of interest that is due and unpaid, reversal of previously accrued but uncollected interest on nonperforming assets, adequate provisions for actual or potential loan losses, and guidelines for recognition of foreign exchange and other losses.

One way to accomplish this is to establish minimum standards as part of the legal framework. Another way is for the local professional accounting body to enact standards having the force of law. In countries where a local accounting body does not exist or where the local professional body is very weak, actions will be necessary to establish or enhance the role of a professional body and strengthen the profession by providing training courses at both the university and professional levels, encouraging university students to enter the field of accounting as a career, providing library and research facilities, establishing a professional advisory service and peer review, and imposing sanctions against auditors who consistently perform below acceptable standards. In addition, public policymakers must demonstrate a commitment to supporting the industry's efforts to strengthen its standards and performance.