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A Bill to expose banks’ false profits, overstated capital and hidden losses

On Tuesday 15 March 2011, Steve Baker MP introduced a Bill to require certain financial institutions to prepare parallel accounts on the basis of the lower of historic cost and mark to market for their exposure to derivatives; and for connected purposes. Steve explained how the accounting rules for banks incentivize trading in derivatives by enabling unrealized profits to be booked up-front, leading to large but unjustified bonuses and dividends.

More broadly, banks are producing accounts that grossly inflate their profits and capital in three ways:

  • Using mark-to-market and mark-to-model accounting, banks record unrealized gains in investments as profits.
  • IFRS prevents banks from making prudent provision for expected loan losses by allowing recognition only of incurred losses.
  • IFRS encourages banks not to deduct staff compensation from profits.

Taken together, these flaws mean that banks’ accounts under IFRS are at once rule-compliant and dangerously misleading. The Bill deals with this broad problem. For much more detail, see Gordon Kerr’s Adam Smith Institute pamphlet, The Law of Opposites.

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