BY DAVID BENOIT

NEW YORK—Bank of America Corp. said it would start reducing loan balances for military borrowers who are struggling to pay their mortgages as they leave active duty.

The announcement comes two days after bank executives said reducing principals creates a “moral hazard” in the industry, and as banks fight back against a proposal from state attorneys generals that could affect how the mortgage-servicing industry works.

The Charlotte bank said it is providing military homeowners who owe more than their houses are worth with a “waterfall of solutions.” Also among the initiatives are further reductions in interest rates. The measures go …