Final US goodwill rule issued

Final rule issued to permit the deduction of goodwill from Tier I capital

WASHINGTON, DC - The US federal banking and thrift regulatory agencies have approved a final rule to permit a banking organisation to reduce the amount of goodwill it must deduct from Tier I capital by any associated deferred tax liability.

These accounting changes aim to ease banks' capital accounting in light of the financial crisis. Quietly released and scarcely noticed by the media, an interagency notice of proposed rulemaking (NPR) was published on September 15 by the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Office of Thrift Supervision (OTS) and the Federal Reserve that provided for the more favourable accounting treatment of so-called goodwill, an intangible asset that reflects the difference between a bank's market value and its selling price.

Under the rule, the regulatory capital deduction for goodwill would be equal to the maximum capital reduction that could occur as a result of a complete write-off of the goodwill, which is equal to the amount of goodwill reported on the balance sheet under US generally accepted accounting principles, less any associated deferred tax liability. Essentially, the regulators are permitting buyers of banks and thrifts to count some of the goodwill towards meeting their regulatory capital requirements.

The current market turmoil has caused banks to drastically reign in their lending; this new rule is an attempt to reduce the erosion of their capital cushion. Although the move will be welcomed by many, some industry sources have described it as a desperate and dangerous solution.

The goodwill sale was last used during the savings and loan crisis of the 1980s and 1990s, when the Federal Home Loan Board (now the OTS) permitted thrifts to count goodwill towards regulatory capital, which helped many institutions in the short run. However, once it was taken away, the overall cost of the bail-out skyrocketed, as it had masked insolvency and allowed thrifts to become even more leveraged relative to assets. Some say there is a danger the current situation will follow the same path.

The final rule will be effective 30 days after publication in the Federal Register. However, banking organisations may adopt its provisions for purposes of regulatory capital reporting for the period ending December 31, 2008.

Click here for the draft Federal Register notice.