U.S. Comptroller of the Currency John Dugan said the “incurred loss” model banks use to account for loan losses may need to be changed to a more countercyclical approach that would allow provisions to be made earlier in the credit cycle when times are good.


Dugan, who is the administrator of national banks and chief officer of the Office of the Comptroller of the Currency, urged changes to the current accounting model for loan losses in remarks during the annual meeting of the Institute of International Bankers on March 2 in Washington.


“Perversely, as the banking industry experienced a prolonged period of rising and record profits in the booming part of the economic cycle in the earlier part of this decade, the ratio of loan-loss reserves to total loans went down, not up—even though there was broad recognition that the cycle would soon have to turn negative,” he said.


Dugan said that under the incurred loss model, a bank can make a provision to reserves only if it can document that a loss has been “incurred,” meaning the loss is probable and can be reasonably estimated. The easiest way to document those conditions is by referring to historical loss rates and the bank’s own prior loss experience with the type of asset in question.


In a long period of benign economic conditions, recent history becomes a difficult basis of acceptable documentation. Without acceptable documentation, Dugan said, auditors leaned on bankers to reduce provisions or even reduce reserves, resulting in so-called “negative provisioning.” As a result, the industry entered the current downturn without adequate reserves to absorb the losses now being recognized.


Banks and their auditors need to know the degree to which nonhistorical, forward-looking judgmental factors can be used to justify provisions to loan-loss reserves, Dugan said. He suggested changes in the incurred loss model itself may be needed, such to a more forwardlooking “life of the loan” or “expected loss” concept.


Dugan also said current regulatory rules that limit the use of reserves in Tier 2 capital to 1.25% of risk-weighted assets should be revised to remove disincentives to building reserves. Provisions banks have made recently, while a drag on earnings, he said, have not only offset current charge-offs, but have built reserves to substantially higher levels that will help with future loan problems.


“We ought to be talking about capital and reserves, and we ought to be recognizing the fact that, where quarterly losses are caused by reserve-building, that’s a net result that is positive, not negative,” Dugan said. “When a bank takes a loss to build a reserve, it is appropriately recognizing problems that they will see on the horizon, which is all to the good.”


Dugan’s complete remarks are available at



 The nation’s thrifts posted record losses ($13.4 billion) and set aside record amounts in reserves for loan losses ($38.7 billion) in 2008, according to data released by the Office of Thrift Supervision (OTS). However, industry losses of $3 billion in the fourth quarter were an improvement from losses of $8.8 billion in the prior-year quarter and $4.4 billion in the third quarter of 2008. Return on average assets also improved to −1.02% compared with −2.31% in the prior-year quarter and −1.48% in the third quarter of 2008.


The OTS said troubled assets reached their highest level since 1991 and the number of problem thrifts increased to 26 by the end of 2008, up from 11 at the end of 2007.


Then-OTS Director John Reich, who resigned on Feb. 27, said in a press release that the substantial provisions for loan losses put thrifts in a strong position to absorb potential losses and participate in the financial rebound once the nation’s economy emerges from recession.


“I am optimistic that actions taken by thrift managers and boards of directors will position thrifts to be on the leading edge when recovery comes,” he said.


The complete report is available at



 Bank failures in 2008 were at their highest level since 1993, and the industry posted a loss of $26.2 billion in the fourth quarter of 2008—the first quarter banks were collectively in the red since the fourth quarter of 1990—according to the FDIC’s Quarterly Banking Profile. At the same time, however, total deposits increased at the fastest rate for a single quarter in 10 years.


The FDIC said 25 insured institutions failed in 2008—12 alone in the fourth quarter. At year-end, 252 insured institutions with $159 billion in assets were on the regulator’s “Problem List,” which comprises institutions the FDIC considers at high risk of failure.


The fourth quarter’s return on assets of −0.77% was the worst ROA since the −1.1% posted in the second quarter of 1987. Banks’ provisions for loan losses swelled to $69.3 billion in the fourth quarter, an increase of more than 100% from $32.1 billion in the prior-year period.


Total deposits rose $307.9 billion (3.5%) in the quarter. Domestic deposits grew by $274.1 billion (3.8%), and interest- bearing deposits grew by $242.9 billion (4.2%). Total assets of insured banks also increased by $250.7 billion (1.8%) in the fourth quarter.


The Quarterly Banking Profile is available at



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