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Bank Regulators Give Views on Accounting for Equities in Trading Portfolios

The FASB is trying to determine how its plan to limit equity securities to two classifications, instead of the three that exist today, will alter regulators’ supervision of the banking industry. Bank regulators fear that the change will complicate some of the supervisory requirements of the Dodd-Frank Act, but accounting board members want more information about how regulators use GAAP’s requirements before deciding the issue.

The FASB is tentatively scheduled to meet in January 2015 to review the feedback its staff received from bank regulators about their use of accounting standards in two areas of bank supervision.

FASB members said they wanted to solicit the regulators’ views during a November 12, 2014, meeting on the February 2013 Proposed Accounting Standards Update (ASU) No. 2013-220, Financial Instruments—Overall (Subtopic 825-10), Recognition and Measurement of Financial Assets and Financial Liabilities. The FASB is considering eliminating one of the three categories used to classify equities held by banks and other organizations. If the accounting board follows through with the decision, the equities would be valued at their historical cost or their current market value. Changes in the value would be recorded in net income.

Members of the FASB research staff met with representatives from the banking agencies shortly after the board discussion.

The category the FASB wants to eliminate from U.S. GAAP, called available-for-sale, is used for financial instruments that are priced at their fair value but have the changes in value recorded in other comprehensive income, which doesn’t affect net income. The category is used for instruments that the holder intends to keep unless prompted to sell them by a change in strategy or changes in market or business conditions. The FASB expects to retain the available-for-sale category for fixed income securities.

The board also asked the staff to clarify a previous decision by the board regarding the footnote disclosure rules for bank deposits.

Bank regulators had expressed concern about the plan to eliminate the available-for-sale category. The FASB’s research staff told the accounting board that regulators fear that the change will complicate some of the supervisory requirements of the Dodd-Frank Act, including the trading limits in the so-called Volcker Rule, the stricter rules for bank capital, and restrictions on trading in risky securities, because the rules use U.S. GAAP as a benchmark.

Several FASB members said regulators had considerable leeway under the Financial Institution Reform, Recovery and Enforcement Act of 1989 and the Federal Deposit Insurance Corporation Improvement Act of 1991 to disregard GAAP when monitoring banks. But the staff pointed out that the regulators were required to use GAAP at least as a starting point. Board member Thomas Linsmeier said the FASB needed more details about the laws’ requirements.

The staff also reported that their counterparts at the regulatory agencies complained that departing from GAAP in evaluating banks’ equity holdings would require formal rulemaking by the five federal agencies that oversee banks. But board member Lawrence Smith observed that bank regulators in the past had used “less structured processes” to deal with similar types of concerns.

Smith said he would like to see regulators establish their own definition of trading that banks would use in preparing their balance sheets. He noted that banks could then describe in their footnotes the distinction between trading and non-trading that was based on the regulators’ guidance.

“I don’t think that would be problematic,” he said.

FASB Vice Chairman James Kroeker agreed, adding that he didn’t see much difference between securities classified as available-for-sale and those classified as for trading in terms of an entity’s ability to sell them. The FASB could let banks distinguish on the balance sheet which equities were held for “active” trading and those that weren’t.

“You’re permitted to still make that distinction on the balance sheet, but it obviously wouldn’t then create any distinction in reporting performance,” he said. “I’d be wide open to that.”

After further discussion, the board instructed the staff to meet with bank regulators and individual FASB members to clarify regulators’ authority to disregard GAAP and their views on the matter.

On core deposits, the board debated its recent decisions regarding some disclosure rules. Banks will have to provide footnote disclosures about their liabilities attributed to core deposits, a breakdown of the deposits by significant types of accounts, and the total balance for each type of account. Banks will also have to disclose the weighted-average life of the core deposit liabilities based on their historical experience and provide a qualitative description of what management considers to be core deposits—that is, the components that make up the core deposit liability balance.

The board’s decision-making on core deposits is made somewhat more complicated by the lack of a set, legal definition for the term. Bank regulators generally interpret the term as including checking accounts, saving accounts, money market accounts, certificates of deposit, and some other types of accounts. The term is generally employed to distinguish between deposits stemming from the bank’s main customer base that are likely to remain a stable source of funds and deposits that may be the result of a promotional campaign and at risk of leaving the bank once the campaign ends.

“I had concerns about how you audit something that is undefined,” Kroeker said.

“We’re requiring someone to disclose something we don’t define, and that would seem to be problematic,” Smith said, adding that the FASB could mitigate the problem by adding some supplemental disclosure rules.

Other FASB members were less troubled about GAAP’s lack of a definition for core deposits. Marc Siegel said investors could come up with their own estimates, much as they do with retailers’ sales from stores that have been open for at least a year. The calculations help investors weigh a retailer’s growth from its existing business relative to the growth attributable to an expansion campaign that may become difficult to sustain over a long term.

Still, board members disagreed about the substance of their previous decisions. Linsmeier said he distinctly recalled that the board had defined core deposits by stipulating that management draw a distinction between those that are stable and those that result from a “surge.”

Kroeker replied that the board had discussed what regulators consider when evaluating deposits and decided against developing a definition for U.S. GAAP.

Smith said the board didn’t really evaluate what constituted a surge, and for that reason decided that by having banks present the historical weighted averages of the deposits, and then provide additional information about the deposits, investors and creditors could evaluate the proportion of deposits that could be attributed to a surge and the proportion that was stable.

FASB Chairman Russell Golden said the staff should determine for certain whether Proposed ASU No. 2013-220 didn’t include the core deposit definition, and whether it included indicators the board might then include in the final standard’s implementation guidance.

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