WASHINGTON - In the face of intense criticism from bankers, regulators, and lawmakers, an accounting standards group is prepared to back down from a plan that would have severely limited banks' ability to hold funds in reserve against future loan losses.

In a meeting scheduled for Monday, a task force formed by the American Institute of Certified Public Accountants is to present the organization's standards committee with a dramatically revised plan for bringing banks' loan-loss-reserving practices into compliance with generally accepted accounting principles.

A previous proposal would have all but eliminated management's analysis from loan-loss calculations, but the group's latest language would establish far more flexibility. It says "allowance for credit losses estimation is highly subjective and requires a significant degree of judgment," according to a copy obtained Thursday by American Banker.

Industry officials - who a day earlier celebrated a decision by the Financial Accounting Standards Board to ease proposed merger accounting standards - praised the AICPA move.

"We're really glad that they are backing away from advocating a bright-line approach, and tipping their hat to management's judgment," said Richard M. Whiting, executive director of the Financial Services Roundtable.

Allen Sanborn, president and chief executive officer of the Risk Management Association, said in light of recent announcements of unexpected loan losses at major banks, the new proposal was especially welcome.

"It is particularly timely that we get this resolved now, given what we have going on in the economy," he said. "Given we have entered an environment where loan losses are beginning to increase … banks need to be really focused on their portfolios, to make sure that they are managing them well and that loan-loss reserves are adequate."

An earlier draft of the task force's plan would have prevented banks from reserving against commercial loans until they could demonstrate a "significant downgrade" in the loan's rating. Reserves against consumer loans would have been prohibited until specific borrowers went into default. Additionally, it would have barred banks from holding funds against non-specified losses, known as "unallocated" reserves.

That draft, made public in July, was widely criticized by the bankers and regulators, who warned that compliance would have the effect of reducing the ability of bank management to exercise their judgment in setting reserves. Rep. Marge Roukema, chairman of the House Banking subcommittee on financial institutions, warned that the plan "could have important safety and soundness implications."

The draft was also criticized by the AICPA's accounting standards executive committee, which instructed the task force to consider alternative triggers for allowing banks to recognize loan losses.

Frederick Gill, senior technical manager with the AICPA, said that the task force was unable to identify any alternative triggers, adding that the task force had been divided over the original two in the first place. On further discussion, he said, "We lost support for using past-due status as a trigger for consumer loans - we no longer had a majority on the task force."

As discussion progressed, he said, task force members asked, "If you don't need a trigger for consumer loans, then why do you need one for commercial loans? We lost a few people who supported the downgrade status for commercial loans and no longer had a majority supporting that either."

In an Oct. 23 meeting, task force member Greg Norwood, a partner in the Charlotte, N.C., office of the accounting firm KPMG, made an oral presentation that is the basis for the plan that will be presented to the standards committee on Dec. 11. The proposal was to let banks reserve against loans when they have "observable data" that indicates a probable loss. It also recommended that the task force jettison the ban on unallocated reserves because of difficulty in defining precisely what an unallocated reserve is.

The task force "tentatively bought into this changed approach," Mr. Gill said. "At least a majority of the members said, 'This sounds pretty good but we need to see it on paper.' " The version of the plan that will be presented to the standards committee was drafted by a subgroup of the task force, and was circulated in final form on Nov. 23.

"Instead of providing guidance on specific loss recognition for creditors to follow," they wrote, "the task force proposes that loss attributes considered in the allowance for credit losses should be supported by observable data that is relevant to and directly representative of the specific loss attribute."

The group defines observable data as "both internally and externally generated data that is available to and can be regularly obtained by the creditor." For example, the paper said, institutions lending to physician health-care practices may use publicly reported operating cash flow data to assess the health of those loans.

Any final proposal by the task force would have to be approved by the AICPA's standards committee and subjected to public comment before it would be submitted to the Financial Accounting Standards Board, which has final approval over any changes in GAAP. Mr. Gill said that the change in direction puts the task force much further away from a final draft. "It is really a very early stage," he said. "It is almost like we are starting over."

Bank regulators refused to publicly discuss the proposal, but were privately enthusiastic about the move. Bank trade groups, however, uniformly voiced their approval.

Donna Fisher, director of tax and accounting for the American Bankers Association, said, "This is significant progress. The approach that they were taking was unworkable; this looks like it might work."

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