U.S. Comptroller of the Currency John Dugan Monday questioned if an accounting rule to determine future losses on loans during a long period of benign economic conditions made the downturn worse for banks.

At issue is an accounting standard called an "incurred loss" model that a bank can use if a loss is probable and can be reasonably estimated.

To meet that standard, banks have to use historical loss rates but Dugan said it was difficult to determine loss rates during a prolonged period of benign economic conditions.

For period of time prior to the U.S. housing and credit problems, banks posted record profits and the ratio of loan loss reserves to total loans went down, not up, Dugan said.

When the good times came to an end the tidal wave of losses began hitting the shore and banks were forced to recognize losses, he said.

Dugan said the sudden increases in provisions to loan loss reserves has more than offset earnings and eaten into precious capital.

"Stated differently, rather than being counter-cyclical, loan loss provisioning has become decidedly pro-cyclical, magnifying the impact of the downturn," Dugan said in a speech delivered to the Institute of International Bankers.

Under the "incurred loss" model, banks could use historical loss data to predict their future losses. But if data was lacking during good times, banks were prohibited from building their loan reserves, Dugan said.

"Why did our loan loss reserving system produce such a low level of reserves at the beginning of this downturn?" Dugan said.

"Had banks built stronger reserves during the boom years, they would not need to reserve as much now; they wouldn’t need as much additional capital now; and they would be in a stronger position to support economic growth," he said.

Dugan said he along with Securities and Exchange Commission member Kathleen Casey, as part of Financial Stability Forum, are studying the usefulness of the accounting standard governing loss loan provisioning. (Reuters)