The FASB's new credit loss model is one of the most significant accounting changes in recent history. The time to act is now–here's how you can prepare and comply.
In June 2016, the Financial Accounting Standards Board (FASB) issued a new expected credit loss accounting standard, which introduced an updated method for estimating allowances for credit losses. This is referred to as the Current Expected Credit Losses methodology (CECL) and applies to all banks, savings associations, credit unions, and holding companies.
If your institution has not yet adopted CECL, now is the time to refresh yourself on the key changes and—most importantly—to start planning.
The impairment model introduced by the CECL standard is based on expected losses rather than incurred losses. With that, an entity recognizes its estimate of lifetime expected credit losses as an allowance. CECL also strives to reduce complexity by decreasing the amount of credit loss models available to account for debt instruments.
This change was under discussion for many years prior to its issuance, with the impacts of the global economic crisis highlighting the shortcomings of the Allowance for Loan and Lease Losses (ALLL) framework. FASB concluded that the ALLL approach delayed the recognition of credit losses on loans and resulted in loan loss allowances that were insufficient.
|Loans/leases (could be other valuation reserves)||Loans/leases (could be other valuation reserves)|
|Does not apply to HTM investments||Applies to HTM investments|
|Threshold = probable loss||Threshold = expected loss|
|Reporting period focused (“incurred”)||Reporting period + forecast (“life of the asset”)|
|Individual assets (specific reserves) + pools at historical loss||Pools of assets with similar risk characteristics + historical loss adjusted for reasonable/ supportable forecast period|
|Quantitative (data driven) and qualitative (Q-factors)||Shifts focus to qualitative (adjustments based on reasonable forecasts) + quantitative|
Adoption of the new standard will influence internal controls and information likely not previously integrated into financial reporting efforts. In other words, the scope of CECL is far-reaching—spanning corporate governance, modeling, credit analysis, technology, and others. Additionally, CECL affects all entities holding loans, debt securities, trade receivables, and off-balance-sheet credit exposures. In short: it will have significant implications for operations at most financial institutions.
The time to get started—if you haven’t already—is now. This is a significant change with extensive effects and potential risks. Careful—and early—planning is key.
Here are 9 key steps institutions can take to take to achieve CECL compliance:
Finally, it's necessary to take a holistic view to ensure a smooth transition, including:
This standard was effective for many institutions by December 2019, and all others will need to comply by March 2023. These dates are based on the Public Business Entity (PBE) status for institutions. Early adoption was allowed for any institution after December 2018.
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