Earnings season has arrived for the banking sector and many banks are, in essence, trimming their loan-loss reserves to boost their third quarter results.
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The four largest US banks have released 23% of their pretax income, $18.2 billion in reserves, over the last four quarters. Bank reserves have declined over the past nine quarters and regulators are keeping a close eye on the practice.
When the amount banks contribute less to their loan-loss reserves than they write off in bad loans, the result becomes a reserve release.
Too large a release means the boost to earnings will be unsustainable and makes banks look healthier than they really are.
Multiple releases also erode the cushion banks build to offset bad loans, making them more vulnerable during an economic downturn.
Additional releases will increase tensions between the banks and watchdogs on their practices and between regulators and the SEC.
Bank regulators want banks to keep a larger cushion against possible losses; the SEC wants to limit banks’ ability to use reserves to boost earnings.
The Financial Accounting Standards Board (FASB) is considering a switch from the current incurred loss model to an expected loss model that incorporates projections of future losses.
This would require banks to record losses sooner and add to reserves earlier and give a truer picture of banking sector stability