Where credit is due: Why and how you need to prepare for CECL now
Last June, the Financial Accounting Standards Board (FASB) issued the final current expected credit loss (CECL) standard as a prevention technique to avoid a future financial crisis. And if CECL is new to you, you’re not alone.
In a recent Fiserv webinar, more than 70 percent of industry professionals polled admitted to being only “a little” or “somewhat” familiar with FASB’s latest accounting standard. CECL encourages financial service leaders to have a more holistic understanding of their data as well as a strategy to manage credit exposure and explain changes in the reserve over time. While the standard’s effective date isn’t until 2019, regulators, auditors and industry professionals are urging the industry to prepare now. This multi-year period is intentionally provided to give banks enough time to ready themselves to adhere to the new standards.
But many leaders haven’t even begun to take any necessary action.
With potential increases in economic uncertainty and volatility, understanding credit exposure will be critically important in order to remain competitive and profitable. The process to prepare, understand and analyze the needed data should be thorough, thoughtful—and immediate.
Data collection represents one of three phases for successful CECL compliance. FASB urges institutions to gather a potentially significant amount of historical data, so that the assumptions around credit loss are reasonable and supportable. This highlights why it is crucial to start, even though the ruling doesn’t take effect for two years. We’ll look at the need for data and why it is critical to managing credit exposure—in this first of three BAI articles exploring CECL and the steps financial organizations should take to comply.
In a nutshell, what’s CECL?
Simplistically, CECL would require financial service leaders to analyze and understand the relationship between two factors. These are: internal information (how profitable a loan portfolio is for your financial services organization) and external information (GDP and unemployment rates during the examined loan period)—while understanding how this information impacts the behavior of portfolios. Then, this data can be applied to future business decisions. Financial institutions of all types must adhere to CECL requirements, no matter the asset size.
For the foreseeable future, CECL will impact how leaders make strategic decisions and conduct business. While the result remains to be seen, leading experts have stated that organizations could expect a 10 to 50 percent increase in the allowance for loan and lease losses (ALLL) as a result of the CECL model.
Peerless players: Assemble an internal team
The goal to understand the process and identify the data needs can’t be reached by one person in one afternoon. The data-pulling process should involve stakeholders from across the organization and be a visible, transparent activity to those not directly involved. This internal team will help organizations understand CECL’s timeline, what changes come with this new standard, what data needs to be gathered and why.
Consider accounting, finance, IT, risk, credit and treasury as areas to recruit participants. It might help to include members from your organization’s asset/liability committee (ALCO). While some may combine these areas, it is important to tap team participants who represent each discipline, to provide expertise about where to locate certain data.
After assembling the team, you’ll need to figure out where to access the required data in a reliable manner and start gathering it.
From mandate to managing risk: Grasping the importance
CECL represents a major mandate from FASB and will change how banks and credit unions alike conduct business. It’s aimed to improve your organization’s understanding of historical behavior and we are already seeing clients consider business decisions about what lines they have seen as opportunistic—and others that haven’t been fruitful in years.
Looking at this as purely an “accounting” issue may result in the implementation of point solutions that further fragment the data you need to effectively manage risk. Better aligning the data and systems to support strategic business management (including the credit risk management function) will be required in order to comply with the new standard.
Not gathering and understanding the historical data now will make it harder to ensure that an organization’s assumptions about credit losses are reasonable and supportable. And that lack of data could expose the institution to increased scrutiny.
If you haven’t started your CECL preparation, begin now: Your financial service organization should develop a team to establish the process that identifies and gathers the data. We’ll continue to discuss the other phases of CECL, data gathering and application, in the next two articles of this series in BAI Banking Strategies.
Tom Caragher is product manager, Enterprise Performance Management, Fiserv. Mr. Caragher has more than 25 years of experience in direct asset liability and balance sheet management. A master’s degree graduate from Arizona State University, he joined Fiserv in 2005 in product development and product consulting.