Today, in a speech given before the Institute of International Bankers, Comptroller of the Currency John C. Dugan advocated making loan-loss provisions more counter-cyclical and moving away from the current approach that forces banks to build larger reserves during economic downturns. Dugan noted that, at the beginning of the decade, during a period of economic prosperity, the ratio of loan loss reserves to total loans declined, despite increasing evidence that the cycle would soon turn negative. Consequently, when the economic downturn arrived, banks recognized losses through an abrupt increase to loan-loss reserves. Dugan commented that, “[r]ather than being counter-cyclical, loan-loss provisioning has become decidedly pro-cyclical, magnifying the impact of the downturn.” Under the “incurred loss” model, banks could utilize past loss data to predict future losses, but when data was lacking during economic prosperity, banks were prohibited from building their reserves. “Given where we are in the credit cycle, and taking into account all the competing considerations, I think its high time to ask and answer some hard questions about loan loss provisioning.” He went on to say, “[h]ad banks built stronger reserves during the boom years, they would not need to reserve as much now; they wouldn't need as much additional capital now; and they would be in a stronger position to support economic growth."
Dugan also stated that SEC Commissioner Kathleen Casey would join him as part of a Financial Stability Forum working group to review the value of the accounting standard governing loan-loss provisioning and hopes that the group will help to inform the work of standard setters, supervisors and policymakers.