WASHINGTON -- The Federal Reserve Board reluctantly agreed Wednesday that banks should have to adjust equity capital to reflect unrealized gains or losses of the securities they hold for sale.
The Fed governors gave their staff the go-ahead to draw up a proposal for industry comment in cooperation with the three other bank and thrift agencies. That's the first step down a long road to a final rule, which is expected by yearned.
Regulators don't like the mark-to-market rule, because they believe it is a unsound policy that will cause bankers to shorted the maturities of their investments. They say it's being foisted upon them by the accounting profession. In May, the Financial Accounting Standards Board adopted FAS 115, a mark-to-market rule for banks.
"Should accounting procedures govern how an institution is run?" Fed Chairman Alan Greenspan asked. "We have to assume that the action on the part of institutions holding long-or medium-term securities is one based ... on the risk profile of the bank.
But Mr. Greenspan voted for the plan, conceding that, by law, the banking regulators must keep capital rules at least as tough as generally accepted accounting principles.
"I don't see where we have much choice," Fed Vice Chairman David Mullins said. "I would unenthusiastically not oppose the proposal."
Mr. Greenspan predicted that banks will shorted the maturities of their securities portfolios to avoid big hits to capital. He said the government should not be interfering with banks' economic decisions.
Bill Roberts, senior vice president and controller at First Chicago Corp., agreed.
"I think it's a concern for the whole industry because it would motivate banks to modify prudent portfolio practices," he said. "It creates a tension between managing interest-rate risk and managing capital."
But Bill O'Halloran, for Atlanta-based SunTrust Banks Inc. and chairman of the American Bankers Association's accounting committee, is ready to look at the bright side.
"We fought the good fight and lost, now we're looking for upside," he said.
Mr. O'Halloran doesn't have to look far because SunTrust's capital will balloon by $1 billion under the new rules. The bank owns 24 million shares of CocaCola that are currently valued at cost, which was $100,000 back in 1919. Under the new rules, SunTrust declares the Coke stock as "available for sale" and marks it to market, or $1 billion.
SunTrust plans to label its entire $6 billion securities portfolio as available for sale, he said.
Bob Muth, president and chief executive of Ohio's Andover Bank, said he has already shortened the maturity on half the securities in his $30 million portfolio. "In order to prevent that from destroying my entire year's earnings, I just reduced the term of my investment portfolio," he said.
But the $120 million-asset bank is sacrificing about 5% of earnings due to the lower rate he is getting on the shorter-term securities, Mr. Muth figured. "I'm willing to give up 5% rather than have my capital impacted."
"My feeling is it [FAS 115] shouldn't be in regulatory capital at all," said Marti Sworobuk, program manager for accounting financial reporting at the Savings and Community Bankers of America. Unrealized gains or losses in securities available for sale should not be used to measure the strength of a financial institution, she said.
Under the proposal, as spelled out in a Fed staff paper, Tier 1 capital will be adjusted quarterly to reflect changes in the value of securities a bank holds for sale. If these securities go up, Tier 1 will be increased. If the securities decline in value, then the bank's Tier 1 capital also will decrease.