WASHINGTON - In a move coinciding with harsh criticism last week from regulators, a leading accounting trade group has backpedaled slightly on a proposal that would change the way institutions account for loan- loss reserves.

The American Institute of Certified Public Accountants late Friday dropped its insistence that banks use an internal credit risk grading scheme with scores that correspond to those used by ratings agencies such as Moody's Investors Service and Standard & Poor's. Regulators had blasted the idea, saying, "Any attempt to mandate a specific grading system will be burdensome and impractical, particularly for … smaller, less sophisticated institutions."

The AICPA opted instead for a less prescriptive approach, saying,: "The credit risk grading scheme used should identify borrower characteristics that evidence decreasing probability of performance with contractual principal and interest payment requirements."

A system that maps credit risk grades to ratings agency scores was included, as an example, in an appendix to the paper.

The change addressed only one of several objections to the plan that were outlined by the Federal Reserve Board, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Federal Deposit Insurance Corp. in a July 12 letter. Other issues - which industry observers view as more substantive- - were untouched.

AICPA officials said the change was already in the works before they received the regulators' letter.

The proposal is an attempt by an AICPA task force to develop guidelines for applying Generally Accepted Accounting Principles to lenders. It finds that unallocated loan- loss reserves are inconsistent with those principlesGAAP,, and that banks should only be allowed to add to their reserve accounts in the event of a demonstrable loss.

Both findings conflict with current bank practice, and drew fire fromthey generated criticism from bank trade groups, lawmakers, and regulators when they were reported by American Banker last week.

Rep. Marge Roukema, R-N.J., who headschairs House Banking's financial institutions subcommittee, expressed concern last week that the draft proposal would "hinder the ability of bank management … to set an appropriate level for loan- loss reserves."

Specifically, regulators said, the proposal would result in understated reserves, causing financial statements to mask banks' true condition from both investors and regulators.

Elizabeth Fender, the AICPA's director of accounting standards, saidvoiced some frustration with the complaint. "It is hard to address," she said. "They are just concerned that anything we do might make the reserves go down."

The agencies also objected to a provision of the proposal that would limit banks to reserving only in cases of actual default or of credit risk downgrades. They said the restriction would be impractical for banks because they would be forced to review each loan in their portfolios too frequently.

Regulators were mum on Monday when asked to comment on the changes made to the proposal, but trade group representatives were vocal.

"The concerns of the regulators and Chairwoman Roukema are still valid with this draft," said Donna Fisher, director of tax and accounting for the American Bankers Association. "We question whether the result will actually mislead users of financial statements."

The task force's proposal has been through several versions since the group was formed in March of 1999. The most recent will be presented to the AICPA's Accounting Standards Executive Committee on July 26.

AICPA officials said the committee is unlikely to vote on the proposal in at the July meeting, but will likely suggest further changes. When the committee adopts a position, which it could do later this year, the document will be submitted to the Financial Accounting Standards Board. FASB approval would send it out for a 90-day public comment period, after which its recommendations would become standard accounting practice.

The group was formed in the midst of a battle between bank regulators and the Securities and Exchange Commission over banks' loan- loss reserves.

The SEC forced Sun TrustSunTrust Banks Inc. to restate three years worth of earnings and reduce reserves by $100 million in late 1998, claiming that it and other banks use the reserve accounts to "manage": their earnings. Regulators retaliated by claiming that reserves are necessary for banks' safety and soundness and should be maintained at or above current levels.

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