CECL: Solution in Search of a Problem

Last week the Financial Accounting Standards Board (FASB) released its final version of the new loan loss accounting methodology, known as the Current Expected Credit Loss (CECL) model. CECL has been described by banking regulators as “the biggest change to bank accounting ever.” Both the Independent Community Bankers of America and American Bankers Association have been working with FASB on CECL, practically since it was introduced in 2012. The new rules are effective for Securities and Exchange Commission-registered firms in 2020 and for all others in 2021, but bankers will need to begin immediately to determine what additional data will be required for their institutions, and how they will forecast and quantify losses in the future.

Essentially, CECL changes from the current incurred loss method of funding the loan loss reserve to requiring the recording at the time of loan origination of credit losses expected throughout the life of the loan or held to maturity securities. Most experts have determined that the result will be loan loss reserves at much higher levels than they have ever been.

A huge concern for both the ABA and ICBA is whether sophisticated software will have to be acquired, even by the smallest of banks, in order to make the required calculations. ICBA appears satisfied that this will not be required, while ABA remains unconvinced. Regardless, it appears that a significant amount of changes will be required of all institutions to document assumptions used during their calculations. Countless hours will be required to make this conversion.

My frustration with this new standard is that it is a solution in search of a problem. Some say that the banking industry did not have enough loan loss reserves to weather the storm of the recent financial crisis. That is true. In fact some banks did not even have enough capital to cover the losses they experienced, so what does it matter how much money is in the accounting-created reserve for loan losses? The accounting business established the concept of loan loss reserves, so that an accounting buffer was created to cover anticipated losses. I understand that. However, determining future losses will never be an exact science, so why go through this exercise of creating a new system that is unlikely to produce better results during a time of high stress than the current system did? Why should the banking business be subjected to wasting valuable hours and dollars on a system created to estimate future losses, when the real loan loss reserve is all of a bank’s capital?

Since the financial crisis, banks have had to deal with enough issues through regulations and capital adequacy determinations, and CECL seems like an unnecessary piling on by FASB. Regardless, it is going to happen, so bankers must learn how to provide this new CECL system in their institutions. Even if the compliance date seems far into the future, banks should begin preparing today.

Bankers are resilient and compliant professionals, so this industry will manage to figure out CECL. For some bankers, though, this may be the straw that breaks the camel’s back. Sadly, this unnecessary requirement will likely cause some to give up and sell their institutions, thus reducing financial intermediary options even further. Thus this solution in search of a problem may create a larger problem still.

– S. Joe DeHaven


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