Problem:
In July 1990, the U.S. federal regulators ordered U.S. banks to write off 20% of their $11.1 billion in loans to Brazil, and 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 write-off would not automatically have an impact on bank earnings.
Required:
Question 1: Why won't the ordered write-offs automatically impact bank earnings?
Question 2: Might the ordered write- offs have an indirect impact on future bank earnings?
Question 3: What effect would you expect to see on the banks' stock prices in response to this announcement?
Note: Be sure to show how you arrived at your answer.