How Banks Can Get Ready for CECL

The Financial Accounting Standards Board (FASB) this month issued new standards for how to estimate credit losses on loans, but they won’t go into effect for several more years.  The standards, known as current expected credit losses (CECL), will affect every bank, no matter its size.

FASB did not specify a method for measuring expected credit losses. Instead, it opted to allow banks to “leverage its current systems and methods for recording the allowance for credit losses.” But banks will need to use “reasonable and supportable forecasts” as part of their calculations.

Bank regulators issued a statement on the standards, encouraging banks to assess the potential impact on capital before the standard goes into effect. 

Regulators also stressed that banks will need to collect additional data, depending on which methodology they choose. (See story on “Stress Testing and Vintage Analysis” on page 1.)  Although some trade groups had opposed the use of a vintage analysis for community banks, others say it is an essential tool for CECL. The American Bankers Association noted in a backgrounder that “vintage analysis of charge-offs may best enable analysts to observe how underwriting standards and the economic cycle impact a current loss expectation.”

The ABA’s analysis concludes that CECL may make it more costly to operate a bank. “Bankers will likely be expected to integrate the assumptions used in their CECL loss estimates (mainly those pertaining to forecasts of the future) with those used in asset/liability management, capital management, and overall budgeting,” the ABA noted. “CECL’s requirement to record a life of loan loss estimate at origination (in other words, recognize the cost up front), for practical purposes, will force a bank to weigh the potential risks much more closely before expanding its business. This can change bank behavior.”

Regulators stressed that they expect the new standard to “be scalable” to banks of all sizes. “The agencies do not expect smaller and less complex institutions will need to implement complex modeling techniques,” regulators said.  They said they would “be mindful of the needs of smaller and less complex” banks when developing future guidance about how to implement CECL. They also said they would establish benchmark targets or ranges for the change in allowance levels.

Regulators advised banks to prepare for CECL before it goes into effect by:

• Reading and understanding the new standard.
• Having in-depth discussions with the board, peers, auditors and regulators about the best way to implement CECL, taking into consideration the bank’s size and risks associated with lending and debt securities investments.
• Figuring out which allowance and credit risk management practices can be leveraged when applying CECL.
• Identifying data needs and system changes that will be needed to implement CECL and additional supervisory expectations.
• Determining how and when to start collecting the additional data.
• Calculating the potential impact on capital.