And now, this not-so-trick question: Who within a bank’s operations will feel the impact of the upcoming Current Expected Credit Losses (CECL) accounting standards?
“Everybody,” says Steve Picarillo, managing director and head of risk management practice for Washington D.C.-based Ankura Consulting Group LLC.
Paula King, senior advisor at Austin-based based Abrigo, offers a similar answer: “CECL will affect every aspect of a bank’s operations not related to the deposit side of bank.”
That means many people and departments will require education, training and involvement in testing before next year, when the standard takes effect. From CEOs and CFOS in the home office to the loan officers in the field, there’s an urgency to grasp just what CECL entails and how to implement it.
As CECL requires most banks to take on greater reserves—at least on their long-term loans—that means anyone associated with management, auditing and financial oversight must grasp how that affects the bank’s bottom line. And with greater amounts of data to compile, analyze and store, the technical staff must rise to the occasion. Finally, everyone who develops, prices or sells loans is likely to get involved.
Aside from the bank’s janitorial crew and landscapers, pretty much no one is off the hook.
Taking in the trends
As financial institutions size up CECL’s impact on operations, five major trends have emerged:
1. Senior management and chief financial executives must comprehend how CECL impacts operations and earnings—and explain this changes to investors and outside stakeholders.
“CECL will affect strategic planning within a bank and affect the bank’s bottom line, so the executive management team has to understand the implications and get involved in implementation from the beginning,” says King. “The CFO should be on any CECL committees.” She expects most banks will see at least a short-term decline in earnings due to CECL.
Additionally, Picarillo notes that the investor relations staff needs to communicate CECL’s earnings impact to investors and financial analysts. “If your loan reserves increased by 15 percent, investors will want to know why,” Picarillo says. “If increases in allowances causes a decrease in net income, you have to explain that in a clear and consistent fashion. Consistency in your message is crucial.”
Chip Messick, managing director of Jersey City, New Jersey’s Verisk Financial, expects more volatility in quarter-to-quarter earnings due to CECL that will need explanation.
2. Risk managers and internal auditors need to know how CECL affects the view of their banks’ portfolios.
“CECL will impact the modeling efforts of risk management. It could change how they massage the data they get and how they create their models,” King says.
Auditors should also pivot. “The internal audit teams need an early understanding of CECL and be able to communicate any changes to external auditors and regulators,” Picarillo says. “They also need this knowledge to design effective audit plans.”
“Auditors must make sure the data being used is accurate and properly documented,” notes Messick.
Product development executives, underwriters and officers must tackle required loan product adjustments—especially for life of loans offered and pricing.
“CECL won’t really change the loan products but it may require tweaks,” King says. “Some banks offering a lot of 20- to 30-year mortgages may move toward shorter-term loans—say more 10-year loans,” King says.
Additionally, King notes that many loans will need repricing “to mitigate any allowance increases.”
As a result of the changes product managers make, loan officers will feel the effects. They will need a strong understanding of how CECL impacts the types and prices of the loans they offer and then simply explain changes to potential borrowers, King explains.
Still, Picarillo notes that not all loan divisions will experience identical consequences. For example, commercial and industrial lending (C&I loans), with its typically shorter terms, may not feel the impact as much as longer-term products, such as mortgages.
4. IT staff must adjust how they identify, gather, integrate and store data to make necessary calculations. That may mean recommending new software that existing systems can handle.
“CECL will require banks to keep considerably more data, often including information about performances going back as far as 2006,” Picarillo says. “The sheer amount of past data and data going forward that’s required and needs cleaning will necessitate IT systems changes. That will require a strong understanding by the technical people who have to create the systems and software to handle the data.”
Yet there is more beyond sheer data volume: Tight data system integration comes into play. “It will come down to organizing data into warehouses that encompass information across the entire bank enterprise,” says Messick. “But to create a single system of record, the data needs to be consistent. Many bank units do not always view and record data fields the same way.”
5. All executives must get on board with either stress testing, mock simulations or other practice tests before implementation.
“There will be a lot of stress testing required to make sure all the systems work and the right data has been collected,” says Messick. “Most of the leading banks are underway, but some of the smaller banks have not started this process.”
“We recommend a bank try to ideally get at least four quarters of testing,” King says. “If that isn’t possible at this time, have at least several quarters to make sure there are no surprises.”
Beyond stress testing, Picarillo suggests that banks hold “mock” earnings call sessions with senior management and investor relations. “Have your head of investor relations explain how the increase in allowances affected net income and answer anticipated questions,” he says.
In the end, independent actions within a bank to implement CECL just won’t cut it. “Banks have to make sure all their executives talk together on this and collaborate,” Messick says.
Assuming that happens, you’ll know exactly what to say when regulators get around to their not-so-trick question: “So who at your bank is in charge of making CECL work?”
Just feel free to repeat the answer above.
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Lauri Giesen has spent more than 25 years writing about banking technology and payments for numerous business and financial publications. In the 1990s, she founded and edited Financial Service Online, a magazine covering Internet-based forays into banking and investment services.