The Financial Accounting Standards Board’s (FASB) Current Expected Credit Loss (CECL) standard goes into effect beginning in 2020 for public organizations that are SEC filers, 2021 for other organizations and 2022 for credit unions.
Already, it’s clear CECL will have a far-reaching effect.
The new credit-loss model requires U.S. financial institutions to estimate life-of-loan losses at origination or purchase. Yet many financial institutions do not have the historical data in place to make those calculations. Here are eight tasks to undertake as your financial institution ramps up to the new standard.
1. Drive CECL implementation by committee
By now, you should have an implementation committee in place, with responsibilities along three main categories: operational, credit and compliance. This committee should include senior leaders from finance, accounting, lending, risk, operations/IT, compliance and retail.
Beyond the essential to-do lists, financial institutions should assign responsibility for integrating systems and processes across the organization and re-evaluate growth strategies.
2. Select your methodology
Financial institutions have plenty of flexibility when it comes to selecting a methodology for evaluating expected credit loss. In fact, the only requirement is to choose an appropriate, practical method—any type that reasonably estimates the expected collectability of financial assets you can consistently apply over time. The right choice depends on the type and size of loans issued by your financial institution (for instance, car loans versus mortgages) and other internal and external factors. Financial institutions can also apply different methods to different asset groups.
3. Compile the data
For financial institutions, compiling all of the needed data to comply with CECL often represents the most challenging, time-consuming aspect of the process. Gathering the right historical data is a staggering task.
To get started, learn what data is required for CECL compliance and compare it to your existing data to see where your institution has gaps. How will you acquire the missing data? Define how you can use data from external or internal sources. Look to external or aggregated sources from peer institutions or extrapolate through historical analysis of data within your organization. Most important: Determine how to put processes in place that capture necessary data going forward.
4. Apply economic forecasts to loans
Moving from the incurred-loss model to an expected-loss model forces financial institutions to consider how to apply economic forecasts to the valuation and protection of loan portfolios. Economic forecasts can provide valuable insight into future performance. For instance, unemployment rates could indicate shortfalls on car loan repayments or other short-term loans, while regional growth factors could positively affect repayment/refinancing of home loans, mortgages and longer-term loans.
Once you’ve assessed and gathered the external data that best suits your loan portfolio, you can develop forecasts that provide an advance look at loan performance and reserve requirements.
5. Store and manage data
Be sure to consider data management, retention and storage when adapting to CECL standards. Many financial institutions are assessing their IT systems and planning investments to meet current and future requirements. Going forward, financial institutions must put the right systems in place to gather data and develop governance strategies to ensure its retention. By combining data from financial accounting and risk management systems, banks can manage and analyze it in a meaningful way.
6. Gain strategic advantage
The CECL requirements mark the first time this much data has been aggregated at the individual financial instrument level. And once that history—that instrument-level data—is captured, good things can happen. With the right data, financial institutions can improve decision-making around credit risk, interest rates and profitability.
For instance, look at loan demand over time, or other key factors for your institution. You can pool and correlate data by collateral or type, including mortgages, auto loans, credit cards and more. You can further segment by cost center, loan officer, FICO score or geography. Consider what level of detail provides meaningful information for your organization. Analyzed data provides a solid foundation for understanding your markets and metrics. This includes how portfolios behave and where potential opportunities lie.
As it helps facilitate risk analysis into interest rates, liquidity, credit, market and regulatory capital, additional data for loans and credit helps forecast and reduce losses. It also helps generate more accurate budget projections. Using data to drive strategic decisions can lead to lower overall risk and better managed return for every stakeholder, including borrowers.
7. Assess your status
If you’re unsure about your organization’s readiness, you may want to listen to this recent podcast from the American Banking Journal, Where Banks Are on CECL, and Where They Need to Be. The CECL experts from ABA explain that by now you should have a process in place and begin analyzing results—with a way to make changes if needed.
8. Make technology work for you
Maybe you held off, hoping for a change of heart from FASB. But with the CECL deadline looming, making progress on implementation is more urgent than ever. Turning to the right CECL solution from a consultative vendor may prove your best bet for meeting the deadline and taking strategic advantage of all that data. You can have a CECL solution up and running in as little as two months.
Consider these five factors when investigating technology solutions: data management; methodology; reporting; technology integration; and strategic guidance and expertise.
The right solution ensures compliance, minimizes reserve requirements and provides insight into data for strategic value over the long term. With CECL just around the corner, start now to accelerate your implementation plans so you can approach the coming deadline with confidence.
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Rick Martin is product manager, Financial & Risk Management Solutions, Fiserv.