The following words have been taken from an HMRC document on stock/inventory realisation.
“The realisable value is the expected sale price of the relevant stock in the condition in which it is expected to be sold in the traders normal selling market. From that value are deducted the estimated further costs which will have to be incurred to get the stock into its normal sale condition to arrive at the net realisable value.”
In other words the lower of cost or net realisable value. Pretty straight forward, but then look at the stress tests being applied to banks.
Now these assessments of the financial strength of banks allow that the market price of sovereign debt may fall. In the case of Greece, banks have been instructed by regulators to factor in falls in the price of that debt of around 23 or 24 per cent (a bit more than regulators first indicated). So if banks hold government bonds, such as those issued by Greece, in their so-called trading books, then those banks have to prove that they are strong enough to withstand fairly substantial losses on those bonds. It has given rise to a new expression of taking a “haircut” but if you are already bald…….
But the nonsense gets even worse - if banks hold government bonds, such as Greek government bonds, in their "banking" books - and thus intend to hold those bonds till they mature or come up for repayment - then those banks would not have to recognise any potential loss on their bond holdings.
So you have an identical instrument held in two “arbitrary” artificial portfolio distinctions each worth a nominal dollar but one is valued at $0.76c having taken a 24% stress related haircut but the other remains valued at $1.00 although the market value is a questionable $0.76c.
How is that a true and fair reflection of reality?
Results of the stress tests are to be released after the market closes tomorrow.
Author: Chris Slay
