In the past decade, several large “money center” banks recorded huge additions to their loan loss reserve. For example, Citicorp recorded a one-time addition to its loan loss reserve totaling about $3 billion. These additions to loan loss reserves led to large net losses for these banks. While most analysts agree that additional reserves were warranted, many speculated the banks recorded more reserve than necessary.
a. Why might a bank choose to record more loan loss reserve than necessary?
b. Explain how overstated loan loss reserves can be used to manage earnings in future years.