Ask any prudential regulator if it is too soon for banks to be releasing loan-loss reserves, and the answer would be "Yes."

Make that, "Hell, yes."

And yet in the second quarter, the biggest banks beefed up earnings by draining reserves. Yes, credit quality did improve, so executives claimed they had no option but to shrink reserves. As is often the case, Jamie Dimon of JPMorgan Chase & Co. was the CEO who put the finest point on it.

Barbara A. Rehm"You should assume we don't like to release loan-loss reserves," Dimon told analysts and reporters on the company's second-quarter call last month. "Put it this way: We will take them down only if we have to."

In other words, blame the accountants.

But when policymakers the world over are fretting over bank capital levels, why are federal regulators standing by and letting banks take down reserves before it is clear that credit quality has turned the corner?

"If you believe capital is too low, then this is sort of ridiculous," said Bob Eisenbeis, a former Atlanta Fed official who is now the chief monetary economist at Cumberland Advisors.

Interestingly, Tim Long, the chief national bank examiner at the Office of the Comptroller of the Currency, used the same word during an interview on the topic.

"For accountants to go in and say, 'Well the recession is over, and now we want you to start making negative provisions,' I think that is just absolutely ridiculous," Long said.

So it's not just bank executives blaming the accountants.

But how is it that bank regulators and bank executives have so little sway over the accountants? Why is the Securities and Exchange Commission's stick bigger than the bank regulators'?

The examiner vs. accountant debate has a long and messy history. Back in the mid-1990s, the SEC went after SunTrust Banks Inc., accusing it of hoarding reserves in flush quarters so it could smooth out earnings by draining them in bad ones. Bank regulators were outraged, claiming the SEC had wandered into safety and soundness territory and should leave such decisions to examiners.

The Gramm-Leach-Bliley Act of 1999 tried to arrange a truce through the Roukema amendment, which required the SEC to "consult and coordinate comments with the appropriate federal banking agency before taking any action or rendering any opinion regarding the manner in which an insured depository institution or depository institution holding company reports loan-loss reserves in its financial statement, including the amount of such reserves."

All the agencies issued policy statements pledging to play nice. Years of record bank profits followed, and the feud went dormant. Until now.

"I don't want them releasing reserves too soon," Long said of the banks he supervises. "We have warned our banks about that. We have told them to be careful."

He added: "I think the bank regulators need to be more assertive in the way that we take ownership of the loan-loss reserve."

And yet it keeps happening. On Aug. 9 CVB Financial Corp. in Ontario, Calif., said that it had received a subpoena from the SEC's Los Angeles office seeking information about how it calculates its loan-loss reserves.

The company's main banking unit, the $6.8 billion-asset Citizens Business Bank, had just been examined by its primary federal regulator, the Federal Deposit Insurance Corp., and reported its second-quarter results, so investors were rattled to discover that the SEC's perspective might differ from the FDIC's. CVB's stock dropped 22% when the subpoena was disclosed and has not fully recovered.

The FDIC declined to discuss the issue, even in general terms, and would not comment specifically on CVB, but the bank's chief executive and president, Christopher D. Myers, told reporters that he hopes the SEC takes a close look at the FDIC's exam report.

No one is arguing that bank regulators are infallible and never miss a reserving call, but they are better positioned than the SEC or the Financial Accounting Standards Board, and it makes more sense to have just one referee on such an important issue.

Accountants want reserves to be based on what's actually happenning, but examiners want banks also to consider what's coming. It's a conflict between incurred- versus expected-loss points of view.

The OCC's Long said talks are continuing with the accountants and he is hopeful progress will be made. FASB has a proposal out for comment until Sept. 30 that edges away from the incurred-loss model, but it is still a far cry from the expected-loss model championed by banking regulators. Besides, at FASB's snail-like pace, it may be years before any change is adopted.

"They need to go to an expected-loss model," Long said of the accountants. "The incurred-loss model just does not work. We've got to be realistic about these loan-loss reserves. We've got to be more anticipatory. We need to change the reserving model because it just doesn't work."

So what's the fix?

According to Long, more talking. "We get the accountants to go to an expected-loss model, which we are working on," he said. "There has been a lot of discussion about it. It's a fundamental concept and approach that FASB and the accounting industry really need to revisit."


Count Eisenbeis among those who do not understand why the banking agencies don't take bolder steps to stop the too-early release of reserves. "They keep arguing for discretion, and when they have it, they don't use it," he said.

So what could the banking agencies do?

Beyond using their bully pulpit and instructing examiners to object when a bank draws down reserves too soon, they could set a standard for what they view as acceptable levels of reserving at any point in a credit cycle, similarly to how they lay out what it means to be "adequately" or "well" capitalized.

They also could require banks to use Regulatory Accounting Principles to report reserving levels approved by examiners. Investors could then compare that figure with what banks report under Generally Accepted Accounting Principles to see just how far apart the bank and its examiner are.

"This cannot get shoved to the back," Long says. "We have got to get this loan-loss model fixed because every time we go into a recession we have the same thing. When the banks can least afford to be raising loan-loss reserves and capital, they are having to do it at the worst time of the cycle because accounting doctrine won't let them do any kind of expected-loss reserve build during good times. It just doesn't make sense."

Barb Rehm is American Banker's editor at large. She welcomes feedback to her weekly column at

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