What are the regulatory accounting principles?
Regulatory Accounting Principles (RAP) were introduced by the former Federal Home Loan Bank Board (FHLBB) for the savings and loan (thrifts) industry it oversaw in the 1980s with disastrous results. Regulatory accounting principles have been created to help low net worth savings and loan associations meet capital requirements. The flawed accounting procedures that the FHLBB allowed savings banks to use freely have been pointed out as one of the underlying causes of the collapse of the savings and credit sector in the late 1980s.
Understanding Regulatory Accounting Principles (RAP)
The relaxed PCR rules have allowed many otherwise insolvent institutions to artificially increase their reported profits and net worth. Some of the blatant accounting principles that savings banks were allowed to apply were as follows:
- Record a loss on the sale of a mortgage loan as an asset that could be amortized over the remaining term of the mortgage. In the 1980s, savings banks held large portfolios of long-term mortgages carried at cost on their balance sheets. The sharp rise in interest rates over the decade caused the market value of these mortgages to drop significantly below book value, but the PAR allowed the losses to be classified as assets. In addition, loss carryforward has enabled thrifts to continue to operate assets with a 3% capital requirement, and to generate tax shields on the amortization of realized losses.
- Full and immediate recognition of construction loan commission income. Active in the real estate market in the 1980s, thrift stores were able to account for fees (2.5% of loan amount) on original construction loans entirely in advance instead of an accounting partial to match the costs incurred for granting the loan, then pro-rated for the balance of the charges over the life of the loan.
- Inclusion of “assessed equity” for the calculation of regulatory net worth. Measured equity, a new concept, was the amount that certain fixed assets such as property, plant and equipment had appreciated above their book value. Savings were allowed to be selective, recording these unrealized gains only for fixed assets whose market values exceeded book values; assets whose market values have fallen below book values could be ignored.
- Amortization of goodwill over forty years of acquired savings funds. The distressed savings funds that were acquired carried significant amounts of mortgage assets well below their book value. By purchasing another thrift store with such assets at a steep discount (fair market value minus book value), the thrift store was able to record income over the estimated life of the assets based on a 10 year interest method. . Goodwill amortization, on the other hand, could be spread over 40 years, which meant that during the 10-year period following the acquisition, the acquirer could make a profit since the annual goodwill amortization expense was much higher. low than under a 10 year requirement that existed. before the implementation of the RAP.
In the aftermath of the savings and loan crisis, Congress eliminated the FHLBB and, with it, the RAP. The Resolution Trust Corporation was formed and the economies that survived were forced to start using GAAP rules.