The Basel Committee on Banking Supervision proposed global standards Wednesday for loan-loss reserves and loan classifications.
"This effort will make the financial system of the world work better," said William J. McDonough, president of the Federal Reserve Bank of New York and chairman of the Basel Committee.
Beyond the United States, few countries have policies on loan-loss reserves and chargeoffs, he said. As a result, banks have devised their own, diverse systems.
"There has been no guidance," he said. "If you look at the financial disclosures of a half dozen major (international) banks, you will see the disclosures are quite varied."
Nicholas LePan, deputy superintendent of Canada's Office of the Superintendent of Financial Institutions who wrote the 40-page proposal, said even banks within the same country use different loan-loss and chargeoff policies.
"Fundamentally, we expect there will be more prudent and timely provision of loan losses and better disclosure by banking organizations of their credit quality and risk-management efforts," Mr. LePan said.
The proposal by the international regulatory body also suggests that banks:
Maintain enough in loan-loss reserves to cover estimated losses.
Charge off loans when it becomes "probable" that the borrower is not going to repay.
Recognize income on a loan when it is earned.
Write off losses on restructured loans.
Disclose data on the amount and geographic concentration of their lending.
The Basel Committee said a uniform policy for chargeoffs and loan-loss reserves is necessary because poor accounting practices may undermine the risk-based capital system by understating a bank's financial woes. Loose accounting rules also may give banks an unfair competitive advantage by not requiring the timely writeoff of bad loans, it said.
The Basel Committee said a bank's chargeoff process should include an analytical framework to assess loan quality and the use of realistic assumptions of future economic growth. "Judgments are necessary, but the scope for actual discretion should be prudently limited," it said.
Bankers may comment on the Basel proposal until March. The group is expected to release final guidance in July.
In wide-ranging remarks during a press conference unveiling the proposal, Mr. McDonough said the Fed has evidence that money-center banks have reduced their lending, but the rest of the industry is still looking for borrowers.
"We are very happy that we do not see any stepping back by regional and community banks," he said. "That is very important because these are the banks that extend loans to medium and small businesses. These are the firms that cause growth."
Still, Mr. McDonough said he is concerned that there has been a "shift to risk aversion," making it harder for corporations to sell debt.
"I wouldn't call it a credit crunch in the fixed-income market," he said. "It is noticeable dry up of liquidity. It means that the cost of capital as reflected in fixed-income markets is increasing."
Short-lived trouble in the fixed-income market would have little effect on the economy, but a prolonged drought of credit would slow economic growth, he said.
Mr. McDonough also predicted more failures by hedge funds. "There will be additional losses announced and recognized," he said. "But we are not aware of any situation which is of even close to comparable size to Long- Term Capital Management's exposure."