Resolving their dispute over loan-loss reserves, federal regulators on Tuesday issued joint guidance on how banks may prepare for economic turbulence without violating accounting rules.
The statement clarifies that banks do not have to link every dollar in reserves to losses on specific loans, the position some feared the Securities and Exchange Commission would advocate. Instead, the agencies said bankers have discretion to bolster reserves.
"Management should always ensure that overall allowance appropriately reflects a margin for the imprecision inherent in most estimates of expected credit losses," the agencies said.
Industry officials had mixed reactions to the policy statement, which is one of the first issued jointly by the banking, thrift, and securities regulators.
"There really is no new guidance here," complained Donna J. Fisher, director of tax and accounting at the American Bankers Association.
"My concern is that it could send out a false signal to the industry that there is some sort of agreement that doesn't exist. They are still talking about looking at banks, even though it is a small number."
Diane M. Casey, national director of financial services at Grant Thorton LLP, put a more positive spin on the agreement. "This is a pretty clear statement that all the agencies have gotten their points across," Ms. Casey said. "The SEC has made clear that it will not tolerate earnings management and the agencies have gotten their point across that estimates are just estimates and that you need to have a margin for error."
Richard J. Whiting, general counsel at the Bankers Roundtable, praised the agencies for reaching an accommodation. "This statement reflects some consistency and some resolution of the industry's problems," he said. "That is important.'
Earnings management occurs when banks stockpile reserves during boom times, which reduces reported earnings, so that they may tap the funds during economic downturns to bolster profits. SunTrust Banks Inc. recently agreed to cut its reserves by $100 million to settle SEC concerns. The deal enraged industry officials, who said securities regulators should not second-guess bank safety-and-soundness decisions.
It also prompted the Federal Reserve Board and Office of the Comptroller of the Currency to write the SEC on Nov. 13 complaining of the crackdown. That letter led to a meeting last week of SEC Chairman Arthur Levitt Jr., Treasury Under Secretary John D. Hawke Jr., Acting Comptroller of the Currency Julie L. Williams, and other regulators.
The inter agency statement also refers to a December 1993 policy on loan-loss reserves released by the banking agencies, which says lenders should use historical data on loan losses when setting reserve levels. It also mentions a 1986 SEC document on loan losses.
The agencies warned that loan-loss reserves must be based on a "comprehensive, adequately documented, and consistently applied analysis" of a bank's loan portfolio.
"It must not be used to manipulate earnings or mislead investors," they wrote.
The agreement was significantly scaled back from earlier drafts. Sources said the SEC balked at providing more detailed guidance or at dropping its threat to investigate more banks suspected of using reserves to manage earnings. "This was a compromise to get it through," one source said.
The agencies agreed to work with banks and accountants to devise additional guidance, and the accounting chiefs at the SEC, the Fed, the OCC, the Federal Deposit Insurance Corp., and the Office of Thrift Supervision agreed to meet quarterly.
Ms. Fisher said the industry would welcome more guidance. "This is a good sign," she said. "It is a sign they will work together. But the question is, what will the guidance be?"
The interagency agreement came as the regulators were coming under increasing pressure to reach a deal. Rep. Bill McCollum on Friday urged the SEC to reconsider its probe of earnings management at banks, saying banks need to bolster reserves because there is a "legitimate fear" that the economy may sour in coming months.
On Tuesday the Bankers Roundtable and the Independent Bankers Association of America sent a joint letter to the SEC arguing that banks need flexibility to set loan-loss reserves.