Preparing against the possibility of an economic downturn, the Office of the Comptroller of the Currency on Wednesday asked national banks to review their loan-loss reserves every quarter.
Senior Deputy Comptroller Emory Wayne Rushton warned that bankers "may be underestimating their vulnerability" by relying too heavily on historical loss rates to determine reserves.
Loss rates of a few years ago may not reflect today's risks, he said. For credit card portfolios, the Comptroller's Office said lenders should not look back any further than 12 months. For aggressive issuers, Mr. Rushton said loss rates should be based on the experience of the last three to six months.
In a five-page advisory memo, the agency repeated some of the warnings it has issued in recent months: Underwriting standards are eroding, particularly in the syndicated loan market, while consumer delinquencies, bankruptcies, and chargeoff rates are rising.
"Although these trends indicate increasing credit risk in the industry, OCC examiners have noted that allowance coverage is declining at some banks," Mr. Rushton wrote.
Mr. Rushton also said national banks must know why their reserves are set at a certain level.
"Some bankers say, 'We'll just set X dollars aside, and that ought to cover it,'" Mr. Rushton said. "We're looking for banks to have an actual formula that justifies the size of the reserve.
"They've got to have the amount adequately documented."
Mr. Rushton also cautioned bankers about loans that are renegotiated. Banks should continue to hold higher reserves against loans that have new repayment schedules, terms, or collateral, he said.
"With these 're-aged' loans, banks reset terms so it looks current, but in fact it's a delinquent loan that they just reconstructed," Mr. Rushton explained. "We're going after those loans. ... Banks should be reserving more for them than a truly current loan."
Upon becoming the agency's bank supervision policy chief in May, Mr. Rushton vowed to communicate regularly with national banks. Last month, he sent out an overview letter; Wednesday's correspondence was the first on a specific topic. Future letters are expected to focus on internal controls and asset securitization.
In an interview Wednesday, Mr. Rushton said a regulator's job is toughest when economic times are good.
"It's hard to get people excited until there is a crisis," he said. "We're doing our best to remind them what happened to them only a decade ago."
