Accounting practice tightened in the wake of banks’ losses
The board that sets U.S. accounting standards on Monday moved to end companies’ use of a device that allowed them to park hundreds of billions of dollars in loans off their balance sheets without capital cushions and has been blamed for helping stoke banks’ losses in the housing boom.
The change will tighten the use of so-called "qualifying special purpose entities" by requiring companies to report to regulators the loans contained in them and to increase their capital reserves in proportion as a cushion against potential losses.
It was the lack of disclosure and absence of capital to support ballooning subprime mortgage loans in these special entities that aggravated the massive losses sustained by banks, regulators say.
The change could result in about $900 billion in assets being brought onto the balance sheets of the nation’s 19 largest banks, according to federal regulators. The information was provided by Citigroup Inc., JPMorgan Chase & Co. and 17 other institutions during the government’s recent "stress tests payday loans in 1 hour."
In general, companies transfer assets from balance sheets to special purpose entities to insulate themselves from risk or to finance a large project. Under the change, many qualifying special purpose entities will have to be moved back to a company’s balance sheet.
Outside investors often take interests in those entities, for example, making an investment in a bank’s holdings of mortgage loans in exchange for payments from borrowers.
Under the new standard, companies must bring back any entity in which they hold an interest that gives them "control over the most significant activities," according to the Financial Accounting Standards Board. Companies must perform analyses to determine that.
In cases where companies have "continuing involvements" with entities off the balance sheet, they will have to provide new disclosures.