District Circular Letters

August 5, 1999

BANKING SUPERVISION AND REGULATION:
LOAN LOSS ALLOWANCE
BASEL COMMITTEE PUBLICATIONS

• The Securities and Exchange Commission (SEC) does not have a policy of seeking reductions in financial institutions' loan loss allowance levels.
• The SEC will consult with the banking agencies as it considers whether to take a significant action regarding an institution's loan loss reserve accounting practices.
• Financial institutions should follow generally accepted accounting principles (GAAP) in establishing loan loss allowances, including the guidance in the Federal Reserve's policy letter (SR letter 99-13; see our letter of June 3, 1999), in financial statements filed with the SEC and the banking agencies.
  

The July 12 joint interagency letter reaffirms the fundamental principles and balanced guidance presented in SR 99-13 by summarizing much of the previous SR letter's guidance and by referencing FASB EITF Topic D-80, which reproduces SR letter 99-13 in its entirety. This guidance reinforces the notions that 1) there is a high degree of management judgment involved in estimating an appropriate allowance and 2) institutions should maintain prudent and conservative, but not excessive, loan loss allowances that fall within an acceptable range of estimated losses. Management's best estimate may be at the high end of the range. An "unallocated" loan loss allowance is appropriate when it is determined in accordance with GAAP.

• Sound Practices for Loan Accounting and Disclosure, addressing issues facing banks and bank supervisors in accounting for loans and loan losses. It is a revised version of a consultative paper issued in October 1998.
• Principles for the Management of Credit Risk, which encourages banking supervisors globally to promote sound practices for managing credit risk. The paper identifies sound practices that banks should use in managing the credit risk in all of their activities, both banking and trading.
  
• Best Practices for Credit Risk Disclosure, which identifies the credit risk information that market participants and supervisors need in order to make a meaningful assessment of banking organizations. The publication encourages such institutions in all countries to provide that information to the public.
• Supervisory Guidance for Managing Settlement Risk in Foreign Exchange Transactions, which is being issued as part of the credit package because settlement risk clearly has a credit risk dimension. The guidance builds on previous work by the Committee on Payments and Settlements Systems of the Bank for International Settlements.
  

Sound Practices for Loan Accounting and Disclosure is final. The Basel Committee invites comments about the other three papers from all interested parties, including bankers, rating agencies, analysts, industry groups, standard-setters, and supervisors. Comments are requested by November 30, 1999, and may be submitted to the Committee's web site, or mailed to

Basel Committee on Banking Supervision
Attention: Mr. William Coen
Bank for International Settlements
CH-4002 Basel, Switzerland

The Basel Committee was established by the central bank Governors of the Group of Ten countries in 1975 and operates under the auspices of the Bank for International Settlements in Basel, Switzerland. The Committee consists of senior supervisory authorities representing the world's largest banking systems and works to strengthen bank supervisory and regulatory practices worldwide.

For Additional Information

FEDERAL RESERVE BANK OF SAN FRANCISCO