Bankers’ Hours column: The tug of war over bank reserves
OK, class, today we’re going to talk about bank reserves.
Wait! Don’t fold up that newspaper and toss it in the nearest bear proof filing receptacle. This could turn out to be interesting.
Reserves represent money set aside for potential losses. In banking, there are two types: general and specific. In the former instance, the bank says that “we don’t have loan losses facing us now, but we could in the future,” so we’ll set aside a certain percentage of our outstanding loans to be prudent. That percentage is based on the bank’s historical losses. When a bank makes this transfer, there’s no tax deduction.
Specific reserves come into play when a bank has identified a problem loan, determined there may be a loss, and a certain amount is set aside as a reserve against that loss. This transfer is deducted from net income.
And this is where the games begin. All federally insured financial institutions are required to, regularly, review their loan portfolios and classify the loans. For those with low classifications, specific reserves are set aside. These allocations come right out of income and net worth, and they can ultimately put a bank in an untenable situation, including being shut down by the FDIC.
During the Great Meltdown, there were a lot of banks that became adept at Creative Classification, hoping things would turn around, which, in most cases, they didn’t. One front range Colorado bank looked very good on paper, until it’s Chief Financial Officer left the building and a new one came on board. He took a look at the loan portfolio, asked, “What are you guys doing,” mandated write downs and reserve transfers, and the FDIC came in within a few weeks, whereupon the institution was history.
On the other hand, there were a few banks with a big capital cushion that reserved aggressively when bad assets were identified. Starting in about 2011, these institutions were, well, smiling all the way to the bank as problem loans were resolved at a lower loss than anticipated. That extra revenue went right to the bottom line and into capital.
Because of past experience, probably no area of banking, except compliance with consumer protection laws, is scrutinized more closely by regulators than loan reserves, and writing down of assets with, the regulators assure us, good reason.
Presently the tug of war between examiners and bank management is in full swing in oil patch lending.
Bank regulators are pressing for write downs of loans related to petroleum exploration and production, and bankers are understandably resistant to what they might characterize as “over-reaction.”
“C’mon, now. We all know this ‘ol boy will recover. No need to panic here,” said the banker to the examiner.
We might have heard that exchange before.
Pat Dalrymple is a western Colorado native and has spent almost 50 years in mortgage lending and banking in the Roaring Fork Valley. He’ll be happy to answer your questions or hear your comments. His e-mail is firstname.lastname@example.org.
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