WASHINGTON - Federal bank and thrift regulators on Thursday said banks may reserve for loan losses by estimating future defaults, placing federal rules on a collision course with changing accounting standards.
The four agencies, in proposed guidelines, said the industry's current practice of reserving for losses that have not yet occurred conforms with generally accepted accounting principles, or GAAP. When a loss may be recognized is part of a larger statement laying out the documentation regulators expect banks to complete to justify their reserve levels.
The proposal, originally expected in March, was published in the Federal Register by the Federal Reserve Board, Office of the Comptroller of the Currency, Office of Thrift Supervision, and Federal Deposit Insurance Corp. It is part of the agencies' July 1999 agreement with the Securities and Exchange Commission to clarify the accounting rules for loan-loss reserves.
A reserve recorded under GAAP, the regulators wrote, "is an institution's best estimate of the probable amount of loans and leases-financing receivables that it will be unable to collect based on current information and events." Estimating the amount of that reserve, they said, "involves a high degree of management judgment and is inevitably imprecise."
But if GAAP is changed, then the agencies said they would have to revisit their rules.
Accounting standards for loss reserves are under review by the American Institute of Certified Public Accountants. In a draft proposal, the AICPA said that a reserve may only be recorded when banks can document an actual loss. An actual loss must be identified by a downgrading in a borrower's credit rating. This would curtail the use of estimates based on historical loss records and decrease the influence of managerial judgment on setting reserve levels.
Frederick Gill, senior technical manager for accounting standards at AICPA, declined to compare the regulators' plan with the institute's. "Our project is a moving target, and it is really hard to make comparisons now because we don't know where we will end up," he said.
The institute's proposal, which was to be presented to the Financial Accounting Standards Board this month, has been sent back for revisions. Mr. Gill said a new version is not likely to be ready until November at the earliest. If FASB approves the plan, it would become part of GAAP.
Bank trade groups had mixed reactions to the banking regulators' proposal. Pam Martin, spokeswoman for RMA, the Philadelphia-based lender trade group, said the agencies "punted" by leaving open the possibility that banks' current reserving practices would have to change if GAAP itself is altered. On the bright side, she said, "it does include two things the AICPA has tried to prevent: the use of historical databases and management's judgment."
The regulators' proposal is open for comment until Nov. 6.