How to Manage the Governance, Operational, and Other Implications of CECL

Is your financial institution prepared to manage the implications of the Current Expected Credit Loss (CECL)? During the recent installment of the Credit Risk Management Audio Conference Series, David Sewell, counsel, Debevoise & Plimpton LLP and Caroline Novogrod Swett, associate, Debevoise & Plimpton LLP provided an overview of the CECL methodology, its history, application to banks, and bank regulatory expectations for implementation, including with respect to governance structures and risk management. 

The current expected credit loss (CECL) methodology is an accounting standard issued by the Financial Accounting Standards Board (FASB) in 2016. CECL requires allowance for credit loss based on an estimate of the expected credit losses on financial assets measured at origination or acquisition. This represents a significant departure from the current incurred loss methodology under generally accepted accounting principles (GAAP). CECL requires recognizing losses earlier and based on more and more complex data; reliance on modeling will increase accordingly. CECL grew out of the 2008–2009 financial crisis and is part of an international effort to address perceived weaknesses in pre-crisis accounting methods.

The transition to CECL will be a staged implementation process. In general, the largest institutions transition first, with full implementation occurring over three years (2020–2022).

Data inputs for CECL are more complex than under the prior standard. Under CECL, the allowance estimate is measured using relevant information about past events, including historical credit loss experience on financial assets with similar risk characteristics, current conditions, and reasonable and supportable forecasts that affect the collectability of the remaining cash flows over the contractual term of the financial assets.

CECL’s reliance on historical data calls for credit loss modeling that is significantly more complex. Developing, testing, and validating these models presents increased operational risk and requires consultation across the enterprise. A cross-functional approach is critical.

An effective CECL implementation requires the development of a unified strategy, operationalized with a CECL playbook, a detailed execution plan, and proper governance to oversee implementation:
1. Consult with board of directors, auditors, and industry peers to identify CECL changes.

2. Evaluate current state of data processes, credit models, governance, internal controls, etc. for challenges to CECL implementation.

3. Develop a detailed CECL implementation plan and integrate via a parallel process.

From a regulatory perspective, bank regulators are closely watching institutions’ implementation of CECL, and have provided information about CECL and articulated broad governance expectations:

  • Interagency notice of proposed rulemaking to amend the capital rule in response to CECL (May 2018)
  • Joint Statement on the New Accounting Standard on Financial Instruments – Credit Losses (June 2016)
  • Interagency Frequently Asked Questions on the New Accounting Standard on Financial Instruments–Credit Losses (December 2016, September 2017)

Banks, especially community and regional institutions, have expressed significant concerns regarding the challenges of implementation and effects on capital. Expectations are evolving and there have been efforts to delay implementation. Ongoing diligence is essential for financial institutions.

For more information and resources about CECL, please download RMA’s informative white paper.

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