Federal banking regulators, increasingly concerned about the deteriorating international financial system, may require U.S. banks to set up a special reserve to account for "problem" international loans.
Regulators said that they are not yet ready to make a formal proposal on such a reserve, but Comptroller of the Currency C. Todd Conover was scheduled to reveal yesterday in a speech to a bankers seminar in Santa Barbara that such a move is possible.
U.S. banks have lent about $200 billion to developing countries, many of which are having difficulties repaying their loans. Poland and Mexico lead the list of financially troubled countries, but other big international borrowers such as Argentina and Brazil also are having troubles.
Regulators at the Comptroller of the Currency's Office, the Federal Deposit Insurance Corp. and the Federal Reserve have the power to make banks set aside funds to cover possible international lending losses, but run the risk that banks would stop further lending to any country pinpointed by regulators. Banks and government officials fear that, if further lending to many developing countries is cut off, those countries might default.
Regulators said they are searching for a way to force banks to treat potential international losses on a uniform and prudent basis without choking off the flow of credit to those countries or creating a diplomatic incident.
But they concede that they have not yet agreed on the details of a special "prudential reserve for problem international loans" -- as Conover called it yesterday.
"It's a live issue," said one high-ranking regulator. "There is more and more of it out now, and more and more banks are struggling with it," he said.
In remarks prepared for the bankers conference, Conover said, "As the headlines over the past six months have made clear, U.S. banks have significant exposure overseas, and some of those loans are in trouble. Banks are reacting to this change in a wide variety of ways. Some are charging off all or part of them. Some are setting aside additional funds in their general reserves. Some are applying interest payments to principal. And some are doing nothing at all."
Conover said some banks "are not recognizing the value of these loans in a realistic way."
For example, analysts and regulators said many banks have been treating loans to Mexico as if they were perfectly sound risks, even though Mexico has not paid off billions of dollars of loans that have been coming due since August while it tries to refinance its $80 billion in foreign debt.
This not only means that reports by some banks may be misleading, but also that those banks may not be making proper provision for losses on those loans.
Banks can do this because Mexico continues to pay the interest due, but does not pay off the principal as it is supposed to do. Banks that do not classify at least some portion of the Mexican loans as problem assets and make some provision for potential loans, may be misleading depositors and investors, regulators say. One regulator said that banks that have made some provision for Mexican loan problems may be acting more prudently, but may be penalized in the public's mind by having a higher level of problem loans and lower earnings, because provisions for potential loan losses are deducted from profits.
Aside from taking the drastic action of forcing banks to classify foreign loans as either "doubtful" or "loss," all regulators can do today is urge banks to classify the loans as problems ("nonperforming assets" in banking parlance).
The regulators hope the creation of a special classification for international problem loans would give them a middle ground.
Banks regularly decide what portion of their loans are problems and try to make provision for the percentage of those problem loans that eventually will go bad and have to be written off as uncollectible.
Banks deduct from their profits a "provision for loan losses" that is placed into a reserve. When they make the formal decision to write off a loan, the charge is made against the loan loss reserve. Banks that have made provisions for possible foreign lending losses today set aside those funds in the same general pool that is used as a bulwark against domestic corporate and consumer loan losses.