Current Environment of Allowance for Loan and Lease Losses (ALLL) By: Daniel R. McDonald Date: 7/30/09 Tucked into the Treasury Department's proposed regulatory overhaul is a push for banks to put aside more money for losses when times are good. This matter is near and dear to the hearts of bankers and their primary regulators. For more than a decade, banks have been severely restricted by accounting standards and the SEC in building capital reserves for loan losses that are likely to occur but difficult to predict. As a result, banks felt under pressure to keep reserves thin. Fast forward to the present where such restrictions significantly worsened the current financial crisis for banks - the reserves set aside during good times didn't cover losses during the financial crisis leaving banks scrambling for capital. Currently, bankers hold capital reserves mainly for loans to borrowers who are delinquent, or whose default is probable. This restriction means that bank earnings get hit with rising loan loss provisions in bad times, precisely when revenues are in decline.  According to the FDIC, banks reserved $194 billion in the first quarter of 2009 for loan losses - 2.7% of total loans. Compare that to the first quarter of 2006, when all was well with the economy and lending, and reserves were $77.7 billion, a markedly lower 1.1% of loans. The reserve then fell slightly, rather than rise, in the 12 months leading up to the financial crisis. Very quickly, banks had to play catch-up with their reserves. To be sure, not all bankers wanted to build reserves during good times. John Dugan, the Comptroller of the OCC, said in a speech in March, "We do frequently find ourselves in the position of pressing for higher reserves than the accountants and bankers would like."  Whereas bank regulators would like banks to build big loan loss reserves, the SEC worries banks use loan loss provisions to smooth out earnings. The Treasury Department proposal recommends improvements to the accounting standards for loan loss provisioning by the end of 2009 with the goal of easing the stress from these opposing forces - both to the bank and the economy as a whole.