$2.4 billion is not a lot of money when we talk about the US banking sector. Last quarter, that was the amount by which banks decreased their loan loss provisions. Lower provisioning means banks can report higher earnings. Last quarter, bank earnings rose by $2 billion and they reported net income of $42.4 billion—the highest on record.
Loan loss provisions are an accounting item—an expression of the losses banks expect; a reflection of their portfolio’s credit quality. Lower provisions correspond with better portfolio credit quality.
In a June 2013 Wall Street Journal article, Regulators Question Banks on Business Lending Risks, US regulators are reported to be concerned about looser lending standards and wary “…that loosening standards could put the economy at risk if another recession were to hit.” Regulators “…do not want to see the lax practices re-emerge that led to the crisis.” Regulators are reported to be worried that banks’ commercial lending practices “…could put them in jeopardy if corporate borrowers can’t repay.”
Loss provisioning is not an exact science. In March 2013, a new schedule was added to the Call Report—required filings by banks to their regulators—to gain greater insight and transparency into how banks analyze their loan portfolio credit quality and estimate loss allowances.
At WAIN Street, we believe that we can help banks and their regulators by providing a common reference point – the Business Default Index— to communicate about the risks and opportunities inherent in commercial credit portfolios. By being an independent, objective benchmark, the index allows effective risk comparison between portfolios—a concept championed by former Citi CEO Vikram Pandit’s Apples v. Apples call to action. The high-resolution view provided by the index allows for granular intra-portfolio analysis—an idea that the Federal Reserve’s Daniel Tarullo thought bankers should pay more attention to.