Last month, I reviewed a new accounting standard for banks called the current expected credit loss model, dubbed CECL. The financial crisis made it apparent that the current methodology for credit loss reserves fell short.
CECL is designed to improve the quality of financial information, especially approaching and during times of economic stress.Gearing Up
The new accounting standard is being phased in, beginning in 2020 with the nation’s largest publicly traded banks. A recent proposal by rulemakers will defer transition for most other institutions—such as community banks and credit unions—until January 2023.1
Information provided by community banks about CECL preparation indicate that most have started the implementation process by gathering and analyzing data. Some have gone further by selecting a methodology and testing it.
Despite the progress, many bankers continue to express concerns about the transition. These concerns typically center on the time required to prepare, vendor fees, the time and effort needed to obtain and organize data, and even the uncertainty of knowing if they have “gotten it right.”A Suggested Roadmap
So, what advice is being offered by prudential regulators to aid smaller, noncomplex banks in overcoming these transition challenges?Treat the transition like any material project
To start, regulators are advising banks to treat the transition like any material project undertaken by the bank. And any material initiative is best undertaken with a project plan and project team in place. The project team should include representatives from all affected functions of the bank, including the accounting and credit units, information technology staff, and the like.Identify helpful internal and external resources
Early on, the project team should identify helpful resources, which may include the bank’s core service provider, external accounting firm, prudential regulators, the Conference of State Bank Supervisors and the Financial Accounting Standards Board. Individual regulators also have information on websites and have distributed guidance to banks in the forms of frequently asked questions and webinars.Evaluate and estimate
The project team should evaluate appropriate methodologies available to estimate expected credit losses and consider the best way to segment the loan portfolio. Also, banks should not forget the new standard changes accounting for securities, as well.Look at the present loan loss methodology
The project team should review the bank’s existing loan loss methodology to identify systems and reports in place that provide needed information. From there, the team can document what data are currently available and any gaps in information.
Typical data elements include:
- Origination or acquired dates and par amounts
- Maturity dates
- Renewal and modification dates
- Loss and recovery amounts and dates
- Reporting identifiers such as call report categories and general ledger accounts
- Pooling factors such as risk ratings, FICO scores, collateral to loan values and other credit risk drivers
Sometimes, the core service provider will have suggestions to fill data gaps. In other instances, a conversation with the prudential regulator can lead to new ideas.Starting collecting, organizing and analyzing data
From there, the project team can begin to collect, organize and analyze the data. Smaller institutions can successfully do this in an Excel spreadsheet. The step of organizing data can be helpful in determining the reasonableness of the approach and deficiencies in the data. It could influence a decision to select a different method. Prudential regulators can be consulted if issues or concerns arise.Validate the methodology, process and impact
Then, the methodology, process and financial impact can be validated with the board of directors, audit committee and other stakeholders as appropriate.
Perhaps most important of all, regulators are reminding banks that the standard is flexible and intended to leverage existing systems as much as possible. In other words, banks are encouraged to find balance with the project and resources available to the institution, especially for the smallest, noncomplex banks.What’s Next?
Prudential regulators plan to work closely with smaller, noncomplex institutions to monitor overall progress and share information on emerging practices and new resources. Regulators are also available to discuss the capital phase-in option, which permits banks to absorb any impact to regulatory capital over a three-year period.
Notes and References
1 See https://www.fasb.org.