Since being introduced in 2016, the Financial Accounting Standards Board’s revised standard on accounting for credit losses, Current Expected Credit Loss model (CECL), has been a hot topic within the banking industry. It promises to remain one for years to come, as financial institutions seek answers and guidance in adhering to the new rules.
Up until now, most discussions have focused on various model types, data requirements, and disclosure guidelines mandated under the loan loss reserve methodology; however, the reach of CECL will extend far beyond the walls of your accounting and finance departments. In fact, CECL will impact virtually every area within your financial institution, regardless of its size.
Given the scope of CECL, it’s important to understand some of the additional ways the standard will affect your institution. These include:
Vendor management. Through our discussions with clients and those in the industry, it appears as if most institutions are turning to outside professionals for assistance in implementing the standard. Because outsourcing these services doesn’t relieve an institution from its over responsibilities regarding their reserves and reporting requirements related to these reserves, along with the fact that these vendors will have access to confidential loan customer information, potential CECL partners need to be heavily scrutinized during the vendor management process.
During the initial evaluation of vendors, management should conduct a vendor risk assessment, which should include input from functional areas such as internal audit, compliance, information technology, and legal. CECL vendor candidates should then be vetted meticulously to ensure their experience, services, and operating practices meet your needs and adhere to the strictest standards. After a vendor is selected and the contract is reviewed by legal counsel and approved by your board of directors, the vendor’s performance should continue to be monitored over the life of the contract.
Regulatory capital. Under CECL, most institutions will need to maintain additional reserves to cover expected future losses. While regulators have approved a three-year regulatory capital phase-in related to CECL’s impact, the reduction in capital may impact your institution’s capital strategy. To account for the potential capital impact of CECL, some institutions may lower dividend payouts or stock buybacks, determine excess capital needs to be raised or impact M&A strategies.
Lending. Given the almost universally expected increase in reserves based on the life of loan loss requirement, an increase in loan interest rates is likely to follow, at least for those banks who struggle with accurate risk-based pricing. Meanwhile, institutions that adjust their lending strategies and guidelines to account for higher rates could experience a slowdown in loan growth or face some difficult discussions with borrowers about rate adjustments when their credits are renewed.
Vendor management, regulatory capital, and lending are a mere sampling of the many areas within financial institutions that will be touched by CECL. We believe this standard will have the most significant impact on the industry of any standard in recent memory. Given the standard will be applicable for most institutions within the next two years, you have little time to waste to begin assessing the impact, not only on your reserves but on all areas of your institution.
We Can Help
To learn more about CECL implementation and compliance, contact an Elliott Davis advisor.