In July 1990, U.S. federal regulators ordered U.S. banks to write off 20% of their $11.1 billion in loans to Brazil and also 20% of their $2.9 billion in loans to Argentina. The action significantly affected the loan loss reserves, that is, Allowance for Bad Debts, of the banks. For example, Citicorp was ordered to write off loans totaling $780 million, compared to Citicorp’s total loan loss reserve of $3.3 billion. However, it was reported that “the action won’t automatically have any impact on bank earnings.” Prepare a short report answering the following questions:
1. Why won’t the ordered write-offs automatically impact bank earnings?
2. Might the ordered write-offs have an indirect impact on future bank earnings?
3. What effect would you expect to see on bank stock prices in response to this announcement?