One way to look at banking, data, silos and credit loss is to consider the image offered by Peter Cherpak, Executive Vice President and Partner at Ardmore Banking Advisors in west suburban Philadelphia:
“There’s a lot of lost bankers with spreadsheets all doing their own thing, running around, creating trial balances and information that is uncontrolled and redundant,” Cherpak says.
If regulators have their way, many such scenarios of financial chaos could change soon. The Current Expected Credit Loss standard [CECL, pronounced SEE-sil] has been framed as one of the biggest revolutions to hit the financial services sector since the creation of the FDIC in 1933. Still, few people enjoy new compliance standards—and those who don’t want to deal with them might just as well try to stick their heads in the banking sand: a game of “hide and CECL,” if you will.
But smaller banks that view CECL as an opportunity rather than a burden could put themselves at a competitive advantage. Implementing the foundations of this new standard could pave a path to better data management, more precise loan valuations and fewer data siloes that prevent small banks from performing at their best.
Expected losses: a clearer view
The CECL standard is a ruling by the Financial Accounting Standards Board that takes effect in 2020 for SEC registrants, and 2021 for all other banks. It will require banks to gather more data and calculate expected losses over the life of each loan. CECL is partly a response to the financial crisis of 2008. It’s meant to ensure that institutions are better protected, with more reserves set aside in case they incur credit losses in the future.
While 2021 may seem years away, there isn’t much time given how much work banks need to do. Many institutions have focused their CECL efforts on interpretation, not implementation. And most smaller banks lack the staff expertise for modeling credit losses in a quantitative manner, says Will Newcomer. He serves as Vice President, Market Management for the Finance, Risk & Reporting business at Wolters Kluwer.
“There’s a significant lack of resources and expertise,” Newcomer says. “This resource gap runs the gamut from staff to computational capabilities and ultimately to detailed data history going back several years.”
Cherpak authored a white paper on the subject and noted that the new rules mark a major departure from current processes. Thus they’ll require a new approach from community bankers. While many bankers use rudimentary spreadsheets and simple formulas for calculating allowance for loan and lease losses (ALLL), new pools will take into consideration the loan age, terms and loss accumulation periods. An even bigger problem: To perform CECL calculations, community bankers will need more historical data on their loans, borrowers and regional economic performance. And that’s something many smaller banks lack.
From obligation to opportunity
The sooner organizations prepare the better off they’ll be, Cherpak says. Banks should not only ensure they meet the expectations of regulators but also implement processes that improve long-term productivity and value. Looking past the challenges, CECL presents an opportunity to update systems and processes that can ultimately improve the bottom line.
In other words, a process that might seem to take up valuable time can save valuable money. “Those who take advantage of these changes will be the real winners in this,” Cherpak says. “A smaller institution that thinks strategically and takes advantage of the imposed change will be better off than those that try to just get through it.”
Turning CECL compliance into an opportunity starts by framing it as the final piece that forces finance, risk and reporting into a single process, Newcomer says. A well-designed solution for a smaller institution should move towards a detailed database to feed calculation engines and automatically populate reports for different groups.
Tightening data will improve the decision-making process. And many of these banks may find they are under or overpricing relative to the actual loss experience, says Adam Johnson, Executive Vice President and Principal at C. Myers Corporation. “The more you understand your credit experience— what has happened historically and recently as you experiment with new products, pricing and losses—the better a foundation you have and the better decisions you can make going forward.”
Cherpak recently worked with one smaller bank that didn’t realize it was using the wrong loan-to-value in its reporting until it conducted a data assessment. The procedure also eliminates data repetition in departments. “It’s an opportunity to get all this stuff on the table, increase efficiency, and get rid of these redundancies that they’ve created over time,” Cherpak says.
Another area for improvement lies in cross-department planning and discovery as new committees will force many smaller banks to reduce traditional siloes between lending, IT and regulatory departments, he says.
Investing compliance via change and improvement
Banks that actively engage with regulators and monitors, rather than merely address compliance essentials, may discover the same new forward-thinking strategies big banks employ. Institutions that address CECL head on will save time and expense and gain insights on numerous fronts, says James Gellert, Chairman and CEO of Rapid Ratings.
They’ll also have more prompt and accurate lossestimation capability and thus make better assessments of their CECL-optimal business mix.
“The bank that identifies such change ahead of its competition, that refocuses management’s time and attention approximately … will be the bank that wins at CECL,” Gellert says.
Newcomer believes very small institutions with simple loan portfolios will do fine, but mid-market banks may have trouble catching up to implement advanced CECL processes late in game and may become targets for acquisition.
This much is certain: The later banks wait to conform to CECL the fewer options there will be, Johnson concludes.
“They won’t be taking the opportunity to make better pricing and lending and profitability decisions,” he notes. “And certainly over time, you’d expect them to make less effective decisions.”
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