How You Can Achieve Full CECL Compliance Today?
After December 15, 2022, the Current Expected Credit Loss (CECL) model is scheduled to replace the incurred loss model for most established financial institutions. This accounting standard was issued by the Financial Accounting Standards Board (FASB) in 2016 to determine long-term expected credit losses and estimate the adequate allowance for bank reserves. It is enforced by regulators to better prepare financial institutions in case of an economic crisis.
Since then, the FASB has obliged banks to make time to plan and perform updates to their systems for regulatory compliance. And because small financial institutions generally need more time to adopt new accounting updates, these banks are given until January 1, 2023, to implement the CECL standard. By then, all banks must consider CECL moving forward for every acquisition and capital raise decision.
Read: The Future of Banking with the Growth of Technology
Adopting the CECL model makes it obligatory for financial institutions to make major changes in their current systems. This involves gathering pertinent data and determining the proper accounting changes for improved transparency and auditability. And to prepare their system for CECL compliance, many banks are looking to invest in effective regulatory reporting software solutions that enable forward-looking estimates of credit losses.
There are many factors to consider when banks transition to a new accounting model. To understand how to achieve a successful transition, here’s how financial institutions can adopt full CECL compliance:
Familiarize Your Organization with the New Accounting Standard
As early as 2016, banks should have been orienting their directors, managers, and staff about CECL and how it diverges from the current incurred loss model that will be phased out. Financial institutions must use the transition period wisely to review industry resources provided by the FASB. That way, they will better understand the purpose of the transition and how it will change specific procedures and systems. Banks are expected to train their staff and the appropriate departments to perform accounting requirements for regulatory compliance. Overall, this should prepare financial institutions to generate forward-looking credit risk frameworks and perform the proper reserve adjustments for expected economic conditions.
Seek Advice from Regulators On the Best Implementation Methods
Financial institutions are encouraged to get assistance from regulators on how to properly implement the CECL model. Besides offering guidance on requirements, regulators can provide specific recommendations based on the size of a bank, the nature of its financial products and services, and the breadth of its lending activities and securities. In short, their advice will be tailored to the complexity and scale of a financial institution’s services. This should result in a more practical and systematic adoption of the CECL standard that enables the bank to perform effectively.
Prioritize System Changes That Require Extensive CECL Updates
Since CECL is an accounting model update, banks must focus on making appropriate changes to systems used by credit risk management staff and accountants. Financial institutions must also create cross-functional teams that are capable of implementing and sustaining the new requirements for the CECL standard. This process involves investing inefficient regulatory reporting software platforms to streamline the process. In particular, small banks must learn to adopt more complex systems that enable them to collect data more efficiently. Investing in the right software system will also enhance computation capacity, allowing them to take advantage of advanced stress testing and modeling capabilities.
Research and Gather the Relevant Data
One of the most arduous aspects of CECL compliance is gathering data for analysis and disclosure. This is especially challenging for small banks that may lack historical data to devise a new accounting computation that aligns with CECL standards. The FASB instructs financial institutions to identify relevant data for reasonable and supportable current expected credit loss projections. The data must also be available, reliable, and objectively verifiable for transparency and audit purposes. Important data that financial institutions might need include information regarding origination and maturity dates, dates by loan and recovery amounts, cumulative loss amounts, and other related risk information. By collecting the right data, banks can implement better CECL models.
Determine an Appropriate Computation Model and Implementation Plan
Financial institutions must come up with an effective computation model and implementation plan that upholds CECL standards. This is a major challenge for banks as they must stand by their decisions, defend their position, and clearly explain how they adopted the CECL model to auditors and regulators. Since banks are allowed to use several methodologies and models to calculate losses, it leaves room for their discretion, though it should be noted that said discretion must be qualified accordingly. How banks implement these calculations often depend on the size, nature, and risk of their lending activities. Frameworks and models used for calculating CECL usually yield varied risk-of-loss assumptions for each financial institution.
Read: Core Banking Software Development Journey
Once a bank establishes its computation model and implementation plan, it’s ideal to evaluate it to anticipate possible issues once the CECL standard is implemented. Financial institutions must walk through all systems, evaluate internal controls, and ensure effective reporting for compliance. Finally, banks must seek auditor and regulatory feedback as soon as they can to address deficiencies in their implementation plan.
CECL is an accounting standard that all financial institutions must properly adopt. The advice mentioned above seeks to help banks organize their current system for CECL compliance. More than a regulatory requirement, upholding CECL standards should help banks make forward-looking estimates of credit losses that will more closely resemble loss estimates with current and future economic conditions.