Subjective U.S. bank forecasts to figure in loan loss reserves

Wed Jun 15, 2016 1:17am EDT
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By David Henry

NEW YORK (Reuters) - A U.S. accounting regulator plans to release new rules on Thursday that will change how banks set aside money for bad loans, raising fresh questions about the role of forecasts in their financial reports.

The Financial Accounting Standards Board's goal in setting up the new framework for loan-loss reserves is simple: it wants to reduce the likelihood that investors will get blindsided by a sudden deluge of bad loans, as they did during the 2007-2009 financial crisis.

The new standard will require banks to start setting aside reserves for losses as soon as they make a loan, estimating costs that are "expected." Currently, they only set aside reserves when credit quality deteriorates to the point where losses are "probable."

The fly in the ointment, analysts say, is the estimates will be highly subjective. Bankers will have leeway to base their reserves on forecasts of future economic conditions. Predictions about factors like unemployment, oil prices and interest rates will vary from bank to bank and inevitably affect quarterly results and balance sheets.

"There is a trade-off there," said Vincent Papa, director of financial reporting policy for the CFA Institute, which certifies financial analysts. "There is a lot more discretion being granted."

FASB developed its upcoming standard over more than 10 years, sketching out plans in public meetings and in material posted to the board's website. The final version will be released on Thursday, said spokeswoman Christine Klimek.

The International Accounting Standards Board, followed in Europe and many other areas outside of the United States, modified its standard two years ago, but did not go as far as the FASB.

Questions about loan-loss reserves are at the fore now. Reserves are among the most important numbers in bank financial statements. Because they are at historically low levels, analysts expect them to rise. (For a graphic on loan-loss reserves at U.S. banks, click here:   Continued...

A Citibank ATM is seen in Los Angeles, California, March 10, 2015. REUTERS/Lucy Nicholson