Banking executives are busy preparing for the most significant accounting change in their careers: CECL, the Financial Accounting Standards Board’s (FASB) new Current and Expected Credit Loss model. If it sounds like a mouthful, it’s certainly a handful as well: CECL will replace the existing process used to recognize and calculate credit losses, in place for the past 40 years.
Such a noteworthy change has prompted responses among bankers that range from uncertainty to panic. It doesn’t help that CECL comes (not by design) with a slew of contradictory information. Between debates over model capabilities, implementation approaches and end implications, everyone seems to have an opinion. No wonder many bankers find themselves distracted by the noise.
Forward-thinking bankers are keeping in mind that CECL ultimately serves to make a positive impact on their institutions. Thus they’re staying focused on the four areas where this impact will be felt most: compliance, minimizing reserves, accuracy and use cases for leveraging results. This strategy will enable banks to better manage and benefit from the mandatory changes.
By accommodating CECL requirements, banks serve a crucial goal: to demonstrate compliance as judged by their examiners. Simply viewing the regulation as another box to check amounts to a mistake. Uncertainty remains around what regulators will expect and if institutions choose to meet just the most basic CECL requirements—in hopes to merely get by—they risk increased regulatory scrutiny and subsequent directives to improve. Proactive financial institutions that adopt a comprehensive CECL strategy, and leverage a more advanced model from the onset, will find themselves better positioned to be in full compliance.
After compliance, most organizations aim to minimize their reserve requirements. There’s speculation and fear of a possible 30-50 percent increase in reserves in the near future. Banks with low levels of capital could face a serious threat with this adjustment: a potential impact to their dividend policies and acquisition plans. There’s no reason to go to such extremes; a more reliable model for estimating credit loss can help bankers predict and manage their individual reserve levels with precision and confidence.
If models cannot predict losses based on the latest economic forecasts, then banks become vulnerable to a range of pitfalls. Small inaccuracies in budget forecasting can lead to devastating decisions, no matter how wise the banker. Investing in a sophisticated and accurate CECL model will better position banks through good and bad economic periods.
Using CECL results
CECL results become most beneficial to a bank that analyzes and integrates them into an existing financial management processes. This conversation should begin immediately. Some top areas that can benefit from the reporting include budgeting, profitability analysis, pricing new transactions and optimizing loan portfolios. Planning for and prioritizing how to leverage CECL results will not only make the transition easier, but potentially more profitable as well.
While numerous potential advantages stem from the new CECL requirements, financial institutions can only realize them if they conduct proper research and due diligence into which model and partner is right for their specific needs. Even though the compliance date may seem far off, it actually looms just around the corner, especially when you consider the many complicated tasks ahead—tasks that involve model decisions, data collection, archiving and partner coordination. All this must happen to properly prepare for CECL. Financial institutions cannot wait any longer to put their CECL plans into place.
In the final analysis, banks should regard CECL as a new strategic initiative and business model, not just another compliance requirement through which they passively reach the lowest threshold. Active management of credit risk, and integration of these potential credit losses, will prove key to determining how banks should conduct their business in the coming years.
Banks that adopt a strategic plan now and focus on the positive impact it can have will find themselves much better prepared for the quickly-approaching compliance deadline and beyond. The temptation to wait until the last minute, in this case, no longer applies: Given all the work that needs to be done, that minute passed months ago. But rewards for tackling the CECL requirements–and leveraging the results to drive smart business decisions—will extend for years afterwards.
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