Letter to the Editor: Ludwig Sounds False Alarm About Loan-Loss Proposal

I found the Viewpoints article by former Comptroller of the Currency Eugene Ludwig ["Plan to Restrict Reserving Is a Nightmare, Ludwig Says," Dec. 1, page 14] to be overly simplistic to the point of confusing the dialogue on the loan-loss reserve proposal by the American Institute of Certified Public Accountants.

I must admit to not having read the text of the proposal, but I have kept abreast of the discussion through the news and current literature and as a banker of 25 years, including roles as commercial lender, manager of credit review, and treasurer at a $30 billion-asset financial institution.

I have not heard the AICPA take the position that banks should not have an appropriate cushion for future loan losses - only that the loan-loss reserve should be limited to known or expected losses. Typically, that reserve is created by a debit to the bank's P&L (the "loan-loss provision," thereby lowering net income and the resulting equity) and a credit to the asset account called "loans," shown as an offset to gross loans and called "loan-loss reserve." In the absence of such a debt and credit, the loan-loss reserve would be smaller but the equity larger. Therefore, the bank would have the same level of cushion for losses.

My training said that reserves are for expected losses, and equity is for unexpected losses. This approach seems consistent with the AICPA proposal.

If Mr. Ludwig doesn't address this accounting treatment, it may be because he feels the banks would object to having more equity because it depresses their return on equity, or would reflect more actual income-statement volatility, possibly impacting their stock price.

But if that is so, he should say that rather than raise the phantom alarm that a change in accounting treatment away from loan-loss reserves toward the equity account means weak credit management and a change in the economics of the situation. Such a response from the banks would not be unlike their view of the proposal to drop pooling treatment of acquisitions, another accounting but noneconomic event.

Kenneth E. Schutte
Treasurer
EdwardJones
St. Louis

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