Depository Institutions:

Flexible Accounting Rules Lead to Inflated Financial Reports

AFMD-92-52, Jun 1, 1992

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GAO provided information on: (1) problems with accounting for bank loan losses; and (2) the status of certain Financial Accounting Standards Board (FASB) projects.

GAO found that: (1) accounting rules related to problem bank loans are so ambiguous and flexible that they are being misused to delay recognition of losses in financial reports; (2) although the federal banking agencies have attempted to provide guidance for developing loan loss reserves, guidance for valuing commercial real estate loans has aggravated weaknesses in accounting rules; (3) the FASB project on accounting rules for impaired loans does not address all of the accounting problems, and the FASB-proposed rules would not result in appropriate loss estimates; and (4) until accounting rules are strengthened, federal bank regulators may not recognize problem institutions until it is too late to prevent Bank Insurance Fund losses.

Status Legend:

More Info
  • Review Pending-GAO has not yet assessed implementation status.
  • Open-Actions to satisfy the intent of the recommendation have not been taken or are being planned, or actions that partially satisfy the intent of the recommendation have been taken.
  • Closed-implemented-Actions that satisfy the intent of the recommendation have been taken.
  • Closed-not implemented-While the intent of the recommendation has not been satisfied, time or circumstances have rendered the recommendation invalid.
    • Review Pending
    • Open
    • Closed - implemented
    • Closed - not implemented

    Recommendations for Executive Action

    Recommendation: In implementing the Federal Deposit Insurance Corporation (FDIC) Improvement Act, FDIC, the Federal Reserve Board, the Office of the Comptroller of the Currency (OCC), and the Office of Thrift Supervision (OTS) should change loan-loss recognition and measurement rules for nonperforming loans used in preparing quarterly reports to the federal banking agencies by requiring that losses be recognized when more than 50 percent probability of loss exists.

    Agency Affected: Department of the Treasury: Office of Thrift Supervision

    Status: Closed - Not Implemented

    Comments: FRB agreed conceptually but believed that regulatory programs addressed underlying concerns. No specific action is planned. GAO referred the issue to Congress.

    Recommendation: In implementing the Federal Deposit Insurance Corporation (FDIC) Improvement Act, FDIC, the Federal Reserve Board, the Office of the Comptroller of the Currency (OCC), and the Office of Thrift Supervision (OTS) should change loan-loss recognition and measurement rules for nonperforming loans used in preparing quarterly reports to the federal banking agencies by requiring that losses be recognized when more than 50 percent probability of loss exists.

    Agency Affected: Department of the Treasury: Office of the Comptroller of the Currency

    Status: Closed - Not Implemented

    Comments: FDIC agreed conceptually but believed that regulatory programs addressed underlying concerns. No specific action is planned. GAO referred the issue to Congress.

    Recommendation: In implementing the Federal Deposit Insurance Corporation (FDIC) Improvement Act, FDIC, the Federal Reserve Board, the Office of the Comptroller of the Currency (OCC), and the Office of Thrift Supervision (OTS) should change loan-loss recognition and measurement rules for nonperforming loans used in preparing quarterly reports to the federal banking agencies by requiring that losses be recognized when more than 50 percent probability of loss exists.

    Agency Affected: Federal Reserve System: Board of Governors

    Status: Closed - Not Implemented

    Comments: OCC agreed conceptually but believed that its ongoing programs addressed underlying concerns. It did not agree with some of the findings. No specific action is planned. GAO referred the issue to Congress.

    Recommendation: In implementing the FDIC Improvement Act, FDIC, the Federal Reserve Board, OCC, and OTS should change loan-loss recognition and measurement rules for nonperforming loans used in preparing quarterly reports to the federal banking agencies by requiring that current market prices be used to value nonperforming loans.

    Agency Affected: Federal Reserve System: Board of Governors

    Status: Closed - Not Implemented

    Comments: OCC agreed conceptually but believed that its ongoing programs addressed underlying concerns. It did not agree with some of the findings. No specific action is planned. GAO referred the issue to Congress.

    Recommendation: In implementing the FDIC Improvement Act, FDIC, the Federal Reserve Board, OCC, and OTS should change loan-loss recognition and measurement rules for nonperforming loans used in preparing quarterly reports to the federal banking agencies by requiring that current market prices be used to value nonperforming loans.

    Agency Affected: Federal Deposit Insurance Corporation

    Status: Closed - Not Implemented

    Comments: FRB agreed conceptually but believed that regulatory programs addressed underlying concerns. No specific action is planned. GAO referred the issue to Congress.

    Recommendation: In implementing the FDIC Improvement Act, FDIC, the Federal Reserve Board, OCC, and OTS should change loan-loss recognition and measurement rules for nonperforming loans used in preparing quarterly reports to the federal banking agencies by requiring that current market prices be used to value nonperforming loans.

    Agency Affected: Department of the Treasury: Office of Thrift Supervision

    Status: Closed - Not Implemented

    Comments: The agency agreed conceptually but believed that regulatory programs addressed underlying concerns. No specific action is planned. GAO referred the issue to Congress.

    Recommendation: In implementing the FDIC Improvement Act, FDIC, the Federal Reserve Board, OCC, and OTS should change loan-loss recognition and measurement rules for nonperforming loans used in preparing quarterly reports to the federal banking agencies by requiring that current market prices be used to value nonperforming loans.

    Agency Affected: Senate Committee on Banking, Housing, and Urban Affairs

    Status: Closed - Not Implemented

    Comments: Regulators are developing a joint policy statement on loan loss reserves, but no specific date for completion has been established.

    Recommendation: In implementing the FDIC Improvement Act, FDIC, the Federal Reserve Board, OCC, and OTS should change loan-loss recognition and measurement rules for nonperforming loans used in preparing quarterly reports to the federal banking agencies by requiring that market-based discount rates should be used in discounting cash flows.

    Agency Affected: Federal Deposit Insurance Corporation

    Status: Closed - Not Implemented

    Comments: OCC agreed conceptually but believed that its ongoing programs addressed underlying concerns. It did not agree with some of the findings. No specific action is planned. GAO referred the issue to Congress.

    Recommendation: In implementing the FDIC Improvement Act, FDIC, the Federal Reserve Board, OCC, and OTS should change loan-loss recognition and measurement rules for nonperforming loans used in preparing quarterly reports to the federal banking agencies by requiring that market-based discount rates should be used in discounting cash flows.

    Agency Affected: Congress

    Status: Closed - Not Implemented

    Comments: FRB agreed conceptually but believed that regulatory programs addressed underlying concerns. No specific action is planned. GAO referred the issue to Congress.

    Recommendation: In implementing the FDIC Improvement Act, FDIC, the Federal Reserve Board, OCC, and OTS should change loan-loss recognition and measurement rules for nonperforming loans used in preparing quarterly reports to the federal banking agencies by requiring that market-based discount rates should be used in discounting cash flows.

    Agency Affected: Department of the Treasury: Office of Thrift Supervision

    Status: Closed - Not Implemented

    Comments: FDIC agreed conceptually but believed that regulatory programs addressed underlying concerns. No specific action is planned. GAO referred the issue to Congress.

    Recommendation: In implementing the FDIC Improvement Act, FDIC, the Federal Reserve Board, OCC, and OTS should change loan-loss recognition and measurement rules for nonperforming loans used in preparing quarterly reports to the federal banking agencies by requiring that market-based discount rates should be used in discounting cash flows.

    Agency Affected: Department of the Treasury: Office of the Comptroller of the Currency

    Status: Closed - Not Implemented

    Comments: Regulators are developing a joint policy statement on loan loss reserves, but no specific date for completion has been established.

    Recommendation: In implementing the FDIC Improvement Act, FDIC, the Federal Reserve Board, OCC, and OTS should change loan-loss recognition and measurement rules for nonperforming loans used in preparing quarterly reports to the federal banking agencies by requiring that appropriate periods of time reflecting market conditions should be used to develop fair value estimates when active markets do not exist.

    Agency Affected: Department of the Treasury: Office of the Comptroller of the Currency

    Status: Closed - Not Implemented

    Comments: Regulators are developing a joint policy statement on loan loss reserves, but no specific date for completion has been established.

    Recommendation: In implementing the FDIC Improvement Act, FDIC, the Federal Reserve Board, OCC, and OTS should change loan-loss recognition and measurement rules for nonperforming loans used in preparing quarterly reports to the federal banking agencies by requiring that appropriate periods of time reflecting market conditions should be used to develop fair value estimates when active markets do not exist.

    Agency Affected: Federal Reserve System: Board of Governors

    Status: Closed - Not Implemented

    Comments: FDIC agreed conceptually but believed that regulatory programs addressed underlying concerns. No specific action is planned. GAO referred the issue to Congress.

    Recommendation: In implementing the FDIC Improvement Act, FDIC, the Federal Reserve Board, OCC, and OTS should change loan-loss recognition and measurement rules for nonperforming loans used in preparing quarterly reports to the federal banking agencies by requiring that appropriate periods of time reflecting market conditions should be used to develop fair value estimates when active markets do not exist.

    Agency Affected: Federal Deposit Insurance Corporation

    Status: Closed - Not Implemented

    Comments: FRB agreed conceptually but believed that regulatory programs addressed underlying concerns. No specific action is planned. GAO referred the issue to Congress.

    Recommendation: In implementing the FDIC Improvement Act, FDIC, the Federal Reserve Board, OCC, and OTS should change loan-loss recognition and measurement rules for nonperforming loans used in preparing quarterly reports to the federal banking agencies by requiring that appropriate periods of time reflecting market conditions should be used to develop fair value estimates when active markets do not exist.

    Agency Affected: Department of the Treasury: Office of Thrift Supervision

    Status: Closed - Not Implemented

    Comments: OCC agreed conceptually but believed that its ongoing programs addressed underlying concerns. It did not agree with some of the findings. No specific action is planned. GAO referred the issue to Congress.

    Recommendation: In implementing the Federal Deposit Insurance Corporation (FDIC) Improvement Act, FDIC, the Federal Reserve Board, the Office of the Comptroller of the Currency (OCC), and the Office of Thrift Supervision (OTS) should change loan-loss recognition and measurement rules for nonperforming loans used in preparing quarterly reports to the federal banking agencies by requiring that losses be recognized when more than 50 percent probability of loss exists.

    Agency Affected: Department of the Treasury: Office of Thrift Supervision

    Status: Closed - Not Implemented

    Comments: Regulators are developing a joint policy statement on loan loss reserves, but no specific date for completion has been established.

    Matters for Congressional Consideration

    Matter: The Senate and House Banking Committees may wish to urge the regulators to adopt accounting rules that will reflect the fair value of nonperforming loans for regulatory financial reports. The committees may also wish to urge FASB to adopt such accounting rules as the principles for impaired loans that are currently being developed.

    Status: Closed - Not Implemented

    Comments: The Committee has expressed interest but is monitoring FASB and regulator efforts in reviewing accounting rules as a basis to decide what future action may be needed. Also, the Committee suggested that GAO develop some case studies, which is being done under a separate job.

    Matter: The Senate and House Banking Committees may wish to urge the regulators to adopt accounting rules that will reflect the fair value of nonperforming loans for regulatory financial reports. The committees may also wish to urge FASB to adopt such accounting rules as the principles for impaired loans that are currently being developed.

    Status: Closed - Not Implemented

    Comments: The Committee has expressed interest but is monitoring FASB and regulator efforts in reviewing accounting rules as a basis to decide what future action may be needed. Also, the Committee suggested that GAO develop some case studies, which is being done under a separate job.

    Matter: Absent the adoption of such accounting rules by either the regulators or FASB, Congress may wish to hold hearings and consider legislating such requirements for financial reports prepared for the banking regulators.

    Status: Closed - Not Implemented

    Comments: The Committee suggested that GAO develop some case studies, which is being done under a separate job.