Good asset quality, record earnings, and a strong national economy may be lulling banks into complacency about loan-loss reserves, the Federal Deposit Insurance Corp. warned in a report last week.

When the economy sours, the agency's report concluded, today's riskier loans may overwhelm reserves.

But is the FDIC being too pessimistic?

"The industry has $1.87 in loan-loss reserves for every $1 in noncurrent loans," said Keith Leggett, a senior economist at the American Bankers Association.

"Even if every noncurrent loan was written off, we would still have almost $26 billion in reserves, and this doesn't even count the capital the industry has, which has been growing. We have almost $430 billion in capital."

Even Robert F. Storch, the accounting chief in the FDIC's supervision division, took issue with the report's assumptions.

"From an accounting standpoint, it may well be appropriate that the allowances have gone down as a percentage of loans," he said, given that the quality of current loans is generally "much better" than it was five years ago.

Furthermore, Mr. Storch said, accounting rules don't allow banks to fund loan-loss reserves in anticipation of future portfolio losses.

"The allowance is supposed to be for losses in the current loan and lease portfolio," he said. "You're not supposed to be providing in your allowance today for events that might happen in the future. That's what capital is for."

The report was written by FDIC analyst Andrea Bazemore, who was out of town last week and could not be reached to defend her findings.

In her report, which was included in the FDIC's quarterly regional outlook, Ms. Bazemore said loan- and lease-loss reserves are climbing but are not keeping pace with loan volume. As a proportion of loan volume, reserves have declined in 19 of the last 20 quarters.

The so-called "reserve ratio" at commercial banks-banks where commercial, industrial, and commercial real estate loans totaled more than half of assets-fell 74 basis points, to 1.63%, from 1993 to in 1997, Ms. Bazemore found. Mortgage, agricultural, and multinational banks' reserves also fell significantly.

The only exception to the rule was credit card banks-banks where credit card loans totaled more than 50% of assets. Their reserve ratio rose 86 basis points, to 4.21%.

At the same time, she noted, a number of recent studies have found that loan underwriting standards are declining. Banks with a high concentration of-or significant growth in-riskier loans are at particular risk.

The economy is key, she wrote. So long as it remains robust and bank portfolios grow no riskier, the present level of loan-loss reserves may be sufficient.

But when the economy inevitably begins to shrink again, banks could regret having let their reserve ratios fall so low.

"As the economic expansion reaches an advanced age, insured institutions could experience strains on profitability and capital if allowance levels are inadequate," she said.

The ABA's Mr. Leggett said banks deserve more credit for their foresight, citing their limited exposure in Asia as an illustration. "The economy will change, but the industry will react to that," he said. "We've learned from our past mistakes."

Mr. Leggett concluded with a banker's-eye view on Ms. Bazemore's report.

"You have to remember, the regulators have a different objective function: They're paid to worry," Mr. Leggett said. "And right now I think they're doing an exceptional job."

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