Credit loss standard implementation tips

Accounting and finance employees at banks are quickly learning that FASB’s new expected credit loss standard presents significant implementation challenges.

That’s why experts are advising banks not to delay their implementation efforts. More than two-thirds (70%) of 31 banks participating in a recent Deloitte survey had plans to begin implementation before the end of 2016, while 22% said they would start in 2017, and 6% planned to start in 2018 or later.

Accounting Standards Update No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, was issued in June 2016. The standard requires financial institutions and other organizations to measure all expected credit losses for financial assets held at the reporting date.

The standard is intended to give investors a more forward-looking understanding of financial institutions’ loan portfolios and was developed in response to the most recent financial crisis. In discarding the previous incurred-loss approach, FASB is requiring expected losses to be based on historical experience, current conditions, and reasonable and supportable forecasts.

This current expected credit loss (CECL) standard takes effect for SEC filers beginning after Dec. 15, 2019. Other organizations have an additional year to prepare. That seems like a long time to work on implementation, but the Deloitte survey demonstrated that the largest banks (about three-fourths of respondents have total assets of at least $50 billion) already are gathering resources and personnel to handle this task.

Irv Bisnov, U.S. banking audit leader for Deloitte & Touche LLP, said getting to work early is a good idea for banks.

“Don’t wait,” Bisnov said. “Don’t put this off. This is not something that you’re going to be able to implement in a couple weeks’ time. This is a very, very large initiative.”

But turning your focus to the standard is only the first step. Here are some tips for bank finance executives as they implement the new credit loss standard:

Get the right people involved. That certainly includes a close partnership between finance and the credit risk group because the standard is designed to align the accounting with the economics of lending. “To the extent there are some silos between those two organizations, this is a great time to break down that,” said Jonathan Prejean, CPA, Deloitte & Touche LLP’s advisory CECL leader. Other functions that may need to be involved include IT, internal audit, and compliance.

Leverage existing models. Almost all (94%) of the banks participating in the survey plan to leverage their current regulatory capital processes for implementation of the standard. Points of convergence may exist between the new standard and accounting and regulatory processes such as stress testing, capital adequacy, fair value measurement, and (for global banks) adoption of international credit loss standard IFRS 9, Financial Instruments, which takes effect two years earlier than FASB’s standard. Leveraging the stress-testing models in particular has been popular, but Prejean cautioned against relying on them too much. “The models are made for stress testing, they’re not for credit allowance,” he said.

Look for efficiencies, particularly with technology. A lot of credit-allowance processes at some institutions still use spreadsheets for the calculation, output, aggregation, posting, and reporting of credit losses, Prejean said. This implementation may be an opportunity to automate. “Given the amount of disclosure that will be required, it will be very cumbersome, very difficult to do this manually,” Bisnov said.

Find the right data for forecasting. Nearly one-fourth (23%) of survey respondents said obtaining data necessary for credit modeling and loss estimation will be their biggest challenge as they implement the CECL standard. The most common areas where additional data will be needed to estimate expected credit losses are commercial loans (85% of respondents will need at least some additional data) and credit cards (76% will need more data). Smaller banks—and larger banks that have gone into new lines of business—may struggle here. “They may not have a robust data set,” Prejean said. “They’re going to have to figure out how to get it. Most likely it’s going to come from some external source.”

Consider the effects of higher reserves for loan losses. Upon adoption of the new standard, most banks expect to be required to hold more reserves to cover forecasted losses. A majority of survey respondents expect increases of 10% or more in their total impairment number for consumer loans excluding credit cards (75%), mortgages (71%), and commercial loans (54%). And 58% said they expect the new standard to have some impact on their credit risk practices, while an additional 13% predict it will have a significant impact.

—Ken Tysiac (Kenneth.Tysiac@aicpa-cima.com) is a JofA editorial director.