Should banks reserve through-the-cycle? January 20, 2014 at 9:56 am

The elephant in the accounts is often loan loss reserves, those oh-so-easy-to-manipulate, oh-so-big (if not actually big-eared) amounts that often drive bank earnings. If you though derivatives valuation was dodgy, welcome to the loan book. The most recent, if not the most egregious examples are surveyed in a recent Bloomberg post:

More than 31 percent of JPMorgan’s 2013 earnings, or $5.6 billion, and about 10 percent of Wells Fargo’s, $2.2 billion, weren’t really earned last year. That money came instead from the banks’ so-called loan-loss reserves… [Bank of America] has received the biggest boost from releasing reserves: The move helped it turn $11.8 billion in losses since 2010 into $11.4 billion in profit. Citigroup, which reported $40.4 billion in net income over that time, would have booked about half that amount without the accounting benefit.

This cuts the other way, too. Bank of America would have reported almost $55 billion in profit in 2009 if it weren’t for the $48.6 billion it put back into reserves that year.

This happens of course because loan loss reserves are annual estimates, and things change from year to year. There are proposals to move to provisions which would reflect losses expected over the life of the loan. This ‘through the cycle’ approach might be more stable, and would certainly result in higher levels of provisions, but they won’t hit any time soon*. Perhaps supervisors should give up on the accounting standards setters and set robust standards for regulatory through the cycle EL provisions?

*The current state of play from FASB is : “The Board discussed the next steps on the credit impairment project and decided to continue to refine the Current Expected Credit Loss (CECL) model in the proposed Accounting Standards Update, Financial Instruments—Credit Losses (Subtopic 825-15)… The Boards will continue redeliberations on the CECL model, considering feedback received through comment letters and outreach activities on Exposure Drafts issued.” Dynamic, huh?

2 Responses to “Should banks reserve through-the-cycle?”

  1. If there was a thorough and transparent regime for loan losses (which might be difficult to achieve due to the cross-jurisdiction legal differences, THE excuse I have yet to hear…, but not impossible) – Guess why the FASB/IASB have jointly started stalling tactics for runaways on the impairment for loans, offsetting, leasing etc

    guess the ECB would not need the stress test in the first place……

    Although I liked JP’s “funding adjustment” even more….

    A late Happy New Year, and thanks for a the interesting titbits, they are highly appreciated :-)

  2. Thank you very much El Bufon. A late happy new year to you too. :-)