It's hard to find a banker who believes his bank is over-reserved or under-reserved. Blame the subjectivity involved.

"Loan-loss reserves in an art form, not a science, because it is subjective," said John Lyons, senior principal at Lyons, Zomback and Ostrowski. "When a loan is worthless, everybody can agree on that, but when there is a change in its worth, its hard to quantify that change."

When small banks' portfolios started falling apart in the late 1980s and early 1990s, regulators jacked up the level of reserves to cushion the blow. Portfolio quality may have improved, but banks have been reluctant to reduce reserves.

"Reserves for most banks exceed troubled loans. This is a fairly recent development for the past year," said Federal Deposit Insurance Corp. analyst Ross Waldrop. "What is excessive or adequate is based on the assumption of asset quality."

Over-reservedness "is a reaction or an overreaction to difficult times we've come through. Banks are not so sure the difficult times are over," said Charles Hebert, senior vice-president of Ferguson, Co., Dallas.

Mr. Hebert says three other factors have contributed to reluctance by bankers to adjust reserve levels: the lack of loan demand, the attractiveness of investment securities in comparison to lending risks, and regulatory fear.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.