Will Bank Regulators Diverge from GAAP?

The FDIC will discuss new accounting rules at its board meeting next week, and once again, the idea of slipping free of bothersome rules is likely to be on the table.

Bank regulators are set to discuss accounting standards next week, with an aim toward determining the potential affects that off-balance-sheet rules may have on some financial institutions. During the past year, bankers have fretted about new accounting rules that would force them to bring back on their balance sheets billions of dollars worth of assets — a move bankers have argued will throw regulatory capital ratios into chaos.

As a result, the Federal Deposit Insurance Corp., the federal agency that insures bank deposits, announced it would discuss “the impact of modifications to generally accepted accounting principles” during its August 26 board meeting. What that likely means is board members will debate the practical implications of the rules known as FAS 166 and FAS 167, which beginning in January 2010 will change the way banks and other financial institutions account for securitizations and special-purpose entities (SPEs).

The projects that eventually became FAS 166 and FAS 167 were initiated by FASB at the request of investors, the Securities and Exchange Commission, and the President’s Working Group on Financial Markets. The working group was originally formed by then-President Ronald Reagan in response to the “Black Monday” stock-market crash of 1987.

The new standards revise older accounting rules — specifically FAS 140 and FIN 46(R) — changing the way, for example, companies define control over financial assets and liabilities, thereby causing some off-balance-sheet transactions to be consolidated back on to company financial statements. The rule would likely have a large impact on banks, which frequently package up loans into securities.

The impact of the accounting rules on banks came to a head in May, when the Federal Reserve Board released the results of its so-called stress tests, which were performed on the 19 largest bank holding companies in the United States. The unprecedented stress testing, officially dubbed the Supervisory Capital Assessment Program, incorporated several accounting changes into its modeling, including the potential effects of FAS 166 and FAS 167. In its summary report, the Fed concluded that the new FASB rules would require banks to reconsolidate off-balance-sheet assets tied to securitizations and SPEs.

So far, the estimates of how many billions of dollars would have to be reconsolidated vary, with the Fed guessing that an aggregate $700 billion worth of assets would be brought back on the balance sheets of the largest bank holding companies. News reports have estimated the impact to be closer to $1 trillion worth of assets.

The problem for banks is that as they consolidate the assets, they also will be required by law to increase their capital cushion, something that could prove undoable during a credit crisis.

Banks do have reason to hope, however. While banking regulators usually require GAAP-based reporting from financial institutions, which would include the use of FAS 166 and FAS 167, they can ignore GAAP for regulatory capital purposes. Indeed, that is exactly what happened when banks protested an earlier effort to improve securitization accounting. In 2005, to help quell a bank backlash against FASB’s FIN 46, the Fed announced that accounting rules need not apply to banks.


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