A prominent banking regulator is joining the chorus of cries for more accounting accommodations to help banks look more stable than they really are.

John Dugan, U.S. Comptroller of the Currency, said in a speech to the International Institute of Bankers that the current method for determining loan loss provisions forces banks to build reserves at times when it is most difficult to do so. He said the current model permits banks to make a provision to a loan loss reserve only if it can document that a loss is probable and can be estimated reasonably.

Dugan said the banking sector headed into the current downturn without adequate reserves to absorb the wave of loan losses that now are being recognized. “Given where we are in the credit cycle, and taking into account all the competing considerations, I think it’s high time to ask and answer some hard questions about loan loss provisioning,” Dugan said.

The Office of the Comptroller of the Currency was created by Congress to oversee national banks and assure they are safe, sound, competitive, and profitable. He said a prolonged period of rising and record profits earlier in the decade was accompanied by a reduced ratio of loan loss reserves to total loans, causing the recent tidal wave of loan losses to gobble up reserves and eat into capital. “Rather than being counter-cyclical, loan loss provisioning has become decidedly pro-cyclical, magnifying the impact of the downturn,” he said.

Lynn Turner, former chief accountant for the Securities and Exchange Commission, said Dugan is advocating for banks to record losses before they occur, “setting up in essence cookie-jar reserves during good times to cover losses.” In the post-Sarbanes-Oxley era, policy makers have shown little appetite for “cookie jar” accounting, a practice honed in the market over many years to smooth volatility in earnings.

The result of Dugan’s proposed approach, said Turner, “is banks reporting less profit in good times, when they really are doing well, and more profit in bad times, when they really aren’t making money.” Turner said Dugan’s call for a review of accounting rules can be seen as accommodating banks rather than regulating them. “The OCC knew of the problems and then did absolutely nothing to fix them,” he said.

The Financial Accounting Standards Board took up a project in January 2007 to reconsider the required disclosures around loan loss reserves, but has taken no action since. FASB staff told the board they believe there is “pervasive inconsistency” in how allowances for loan losses are recognized and measured. However, it encouraged the board to stick with the “incurred loss” model currently required in applying Financial Accounting Standards No. 5, Accounting for Contingencies, and No. 114, Accounting by Creditors for Impairment of a Loan.