You are no doubt aware of the significant changes with the implementation of the Current Expected Credit Loss (CECL) accounting standard. CECL represents a major shift in the way that financial institutions have historically estimated and set aside funds for credit losses on loans and other financial instruments. The evolving regulatory scrutiny associated with these new methods, particularly with regard to macroeconomic cycles and industry specific ebbs and flows will have significant impacts on compliance as well as financial statements of banks and other financial institutions.
If you are responsible for implementing CECL at your organization, and whether your organization has already implemented CECL or is still in the process of doing so, there are a few key considerations that you should keep in mind.
Understand the Requirements of CECL
The first step in implementing CECL is to thoroughly understand not only the requirements of the new standard and how it differs from the previous accounting standard, but also the “spirit” and the intent. CECL requires financial institutions to use a “life-of-loan” approach to estimating credit losses, which means that they must consider the total expected credit losses over the expected life of the loan.
This is a departure from the previous “probable” or “incurred” loss approach, which only required institutions to estimate losses that were likely to occur in the short term. This approach largely failed to recognize and account for the risk inherent in all lending activity regardless of the current risk status.
Because credit loss is future oriented, the other major shortcoming of this approach was to adequately look ahead and take into account projected economic conditions that may affect credit quality.
Assess the Impact of CECL on Your Organization
Regulatory matters tend to evolve over time and there can be significant changes in how these issues are evaluated by the agencies. All regulations are subject to interpretation as well as agency and examiner discretion. Credit quality also bears a degree of subjectivity.
It is important to assess the potential impact of CECL on your organization. This will involve conducting a detailed analysis of your current credit loss estimation processes and systems, as well as the data and inputs that you use to calculate credit losses, and how these may or should evolve over time. It may also involve assessing the potential impact on your financial statements and earnings.
Develop a Plan for Implementation & Sustaining a Robust Approach
Once you have a good understanding of the requirements of CECL and the potential impact on your organization, you can begin to develop a plan for implementing and/or sustaining the approach.
This will involve establishing a project team, setting clear objectives and milestones, and identifying the resources and budget that will be required.
Invest in Data
A key universal weakness for many institutions is the lack of reliable data, both historically and data being currently collected.
One component of the intent of CECL was to reduce subjectivity, and this requires good data. Without this, institutions are operating on borrowed time with regard to regulatory compliance, and it is only a matter of time when this will catch up to them. There is no way to have a sustainable program without understanding the importance of data and the key attributes that are needed.
Consider Hiring a Partner to Help Navigate
Implementing CECL can be a complex and time-consuming process, and it may be beneficial to bring in a partner with expertise in this area. A partner can help you to assess your current credit loss estimation processes, develop a plan for implementation and sustainability, and provide guidance and support.
They can also add the credibility of utilizing a third-party expert in addition to the institution’s internal efforts.
Feedback from financial institutions indicates the majority outsource their CECL related credit loss estimation in some form.
Communicate with Stakeholders
As you implement CECL, it is important to keep key stakeholders informed about your progress and any challenges that you are facing. This may include board members, investors, regulators, and other interested parties.
Successful implementation of CECL is no small task, but with careful planning and effective communication, you can ensure a smooth transition and position your organization for success in the new accounting environment. By considering these key factors and potentially hiring a partner to assist with the process, you can help to minimize any disruptions and ensure that your organization is well-prepared for the changes ahead.