Quest Means Business   « Back to Blog Main
September 14, 2010
Posted: 1134 GMT

If you're unclear about the new banking reforms on increased capital reserves, Richard Quest has a clever explanation using Jenga! All you need is one minute thirty seconds to watch this video. Do you think banks increasing capital reserves will help or hinder the economic recovery? Leave us your thoughts in the comments section (right below here), become a fan on Facebook or Tweet Richard your thoughts to @RichardQuest. Be clever and we just might use your response in the show!

Filed under: Business •Quest Means Business

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chris   September 14th, 2010 2:59 pm ET

A clear and lucid demonstration. As always. Bravo!
However, Richard, in my opinion, you maybe missing the crucial point at the heart of this problem. Forgive me me if I am incorrect, but, as I understand it, under the fractional reserve banking system that is in place, changes to Banks capital requirements, is just plain smoke..... a change from 2 to 7% in eight years time, what nonsense. The whole fractional reserve system of banking itself, must be reconsidered. The fiat money that we now accept and use is unfortunately completely worthless. Or restated will be completely worthless when word gets out and people take more interest in matters financial.

Treese   September 14th, 2010 4:00 pm ET

Mr. Quest can work on my basement anytime.

Nicolaas Smith   September 14th, 2010 8:12 pm ET

Richard Quest has to take generally accepted accounting terms into account in his explanations.

A bank’s capital or equity is definitely not an asset in accounting terms. Millions of accountants and accounting, book-keeping and business students world wide would automatically confirm that right this very minute without even thinking about the matter twice. They would smile at Richard’s ignorance of simple accounting terms taking into account that he has a tremendous amount to say about economic matters on a daily basis. They would smile and think that he does not really understand accounting: that his accounting knowledge is sort of very rudimentary and that he should at least get to know a little bit about Accounting 101.

Banking capital for Basel Accord purposes is only different from accounting shareholders´ equity in that long term debt is normally included in Tier 2 bank capital which is not the case with the accounting value “shareholders´ equity”. Neither banking capital nor shareholders´ equity ever includes any asset in accounting terms.

Accounting is double-entry: for every nominal debit there is an equivalent nominal credit under the current Historical Cost paradigm. Please note: in nominal terms – not in real terms. That is what caused the banking crisis in the past and what guarantees banking crises in the future as long as Historical Cost accountants keep on implementing their very destructive stable measuring unit assumption.

Historical Cost accountants simply assume that money always was always perfectly stable (zero inflation) in the past, is always perfectly stable in the present and will always be perfectly stable during low and high inflation and deflation in the future ONLY for the purpose of valuing/measuring all balance sheet constant (not variable) real value non-monetary items, e.g. issued share capital, all other items in shareholders´ equity, etc., and some (salaries, wages, rentals, etc.) – not all – income statement items.

Assets are debits. Issued share capital and shareholders´ equity are credits. In HCA terms, the nominal value of a bank’s shareholders´ equity (or accounting capital) is always equal to the nominal value of NET ASSETS during all levels of low and high inflation and deflation. The nominal value of NET ASSETS (in accounting terms) is always equal to the nominal value of assets minus nominal liabilities during all levels of low and high inflation and deflation.

This is where the real value of the bank´s constant real value non-monetary equity is unknowingly being destroyed by accountants this very moment: it is all accounted in nominal value.

Take for example the current Basel III agreement. It is set in nominal terms. According to a blogging friend: “The international regulatory code Basel III was released overnight. It dictates that required common equity will increase to 4.5% from 2.0% and that a capital conservation buffer of 2.5% is necessary and there is a 9 year span to do so.” I read somewhere else on the internet that inflation is 3% in the UK at the moment. Let’s say it stays at 3% during the next 9 years. Let’s say a UK bank has £10 billion in shareholders´ equity today and that it is also the value of its Tier 1 Basel banking capital with no Tier 2 capital. Currently the bank’s Tier 1 capital can support € 500 billion in assets (10 is 2% of 500). It has to go to 4.5 + 2.5 = 7% in 9 years time. It needs to have 7% Tier 1 capital to support the £500 billion in 9 years´ time, i.e. £35 billion – in nominal terms assuming zero inflation. In 9 years time at 3% annual inflation for 9 years in a row the equivalent nominal value of today’s £500 would be £650 billion and 7% of that would be £45.5 billion.

These problems would be overcome when accountants stop their stable measuring unit assumption and implement financial capital maintenance in units of constant purchasing power as authorized in IFRS twenty one years ago in the Framework, Par 104 (a) which states: “Financial capital maintenance can be measured in either nominal monetary units OR UNITS OF CONSTANT PURCHASING POWER.” (my capitals)

Kindest regards,

Nicolaas Smith

Aqsa   September 14th, 2010 9:35 pm ET

Sir can u tell me the name of the book you suggested for "statistics" on your show?

Gail Duncan   September 15th, 2010 2:13 pm ET

Well done Richard. I understand a bit better now. But tell me, how do we get more people to save, stop buying on credit, recycle and enjoy the simple pleasures more? How do we create more jobs? How do we stop companies from out sourcing and have more people appreciate working outside of their chosen field?

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