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A long-expected change to the rules for provisioning against bad loans is coming soon, and opponents are going on the offensive, arguing that it is impractical and would be especially hard for small banks to comply with. But few concessions, if any, are predicted.
September 29 -
A seemingly minor change to accounting rules governing the treatment of loan losses could effectively serve as a tax on bank acquisitions, say critics. Or not even accounting experts are split, if not confused, about the rule, after three years of debate.
June 12 -
A new accounting framework could give banks a leg up in small-business lending by making it cheaper for companies to provide accurate financials, but accounting experts are divided over whether the standards are an improvement or risky and confusing.
January 27
It is no wonder that the banking industry strongly opposes the Financial Accounting Standards Board's proposed reforms to loan-loss reserve calculations. The proposal would force community banks, in particular, to completely overhaul their approach to lending. Even some FASB members and more than half of the board's own Investor Advisory Committee
The proposal would revamp how banks recognize credit losses on all types of loans. Because community banks follow generally accepted accounting principles — known as GAAP — they normally record a provision for credit losses when they actually have evidence they'll incur a default. But under the FASB plan, known as the Current Expected Credit Loss model, banks of all sizes would instead take a hit the moment they make a loan. Banks would be required to estimate expected credit losses for the life of a financial instrument and recognize the net present value of those losses at the moment of origination.
This is flawed accounting and antithetical to the community banking model itself. Requiring local institutions to institute and maintain complex and expensive credit modeling systems removes their discretion to make localized financial decisions. Pushing up loan losses in the credit-loss cycle to the point of origination also effectively penalizes community banks for investing in loans, which are made predominantly to individuals and small businesses in their local communities.
This will restrict the flow of credit from banks of all kinds. Tying up more capital in loan-loss allowances will mean lower regulatory capital, fewer loans to consumers and even tighter economic growth. The Office of the Comptroller of the Currency estimates that the proposal will increase loan-loss reserves by an average of 30 to 50 percent, which translates into a decline in bank capital to support local lending.
So, the FASB proposal has problems. What can we do about it? Can we address concerns over recognizing credit losses without damaging the community bank business model? Fortunately, community banks are still in the business of finding solutions. To borrow from John Adams, we want to have a better hand at building up than pulling down, which is why we've come up with an alternative proposal.
The ICBA's
This plan would build necessary allowances for potential losses and match each loan's credit risk with its earning potential. It also would recognize reserves sooner in the credit cycle, which meets FASB's objective of reforming the shortfalls exposed during the recent credit crisis. Most important, the alternative removes the principle of recognizing losses on day one, reflecting the fact that losses generally occur later in the life of the loan. This would limit the negative impact on community bank lending.
Nearly 5,000 community bankers have
Camden R. Fine is president and CEO of the Independent Community Bankers of America.