In what may later be termed the banking world's version of "Believe It or Not " it appears that the federal regulators, specifically the Comptroller of the Currency, are now concerned about banks' over-reserving for loan losses.

Mind you, these are the same regulators that a few years ago mandated the massive reserve policies of the past. These guardians have put the industry and its auditors on notice to expect scrutiny of "excessive" reserves. Violators could be assessed a penalty if a bank continues to reserve without "good reason."

In our opinion, this is absolutely unbelievable. Are we to expect penalties for excess capital next?

We can think of two possible motivations behind this change. First, the Clinton administration would like this economy, which is supposedly out of recession, to start acting the part.

In order to rev up our struggling economic engine, banks should be making loans. If financial institutions are reserving, that money is not out in the money supply where it can incrementally multiply.

Lending Can't Be Forced

Of course, the flaw in this theory is that the banks do not necessarily have to lend, especially if there aren't good credits to be booked.

Banks could sock away the excess cash in government securities, mortgage-backed securities or, heaven forbid, exotic new derivative products.

Second, who benefits from this policy reversal? For the most part, small and medium-size banks and thrifts have been building fortress balance sheets by adding to both capital and reserves.

Generally, the balance sheets of the money-center banks are far inferior to those of their smaller brethren in this regard.

Tonic for the Credit Crunch

If the money-center banks have been exercising their clout with the government to exact regulatory relief from "excessive" reserving, this change may dovetail nicely with the government's need to remove the supposed credit crunch and hopefully jump-start the economy.

Here too the theory is flawed. Doesn't anyone remember South America?

In our opinion, having a rainy-day fund in whatever form is not only conservative but prudent. Moreover, most financially sound banking institutions are finding it difficult to utilize their capital.

Loan Demand Lags Behind

The money is in the coffers, but loan demand is nonexistent. If there was loan demand, a financial institution with "excess" reserves could actually be in a position to make more loans.

We find it interesting that the regulators are getting involved in this issue, since excess reserving has traditionally been the province of the Internal Revenue Service (which generally feels every one is hiding money).

Although no economic benefit is derived from moving the excess reserves from the balance sheet to the income statement, we may see some upward price movement in those financial stocks when the move occurs. This would be due to higher earnings being reported.

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