CECL: Providing an Enterprise Wide Opportunity for Integrating Finance, Risk, and Reporting
A key theme for US banks this year will be how finance, risk, and reporting will become truly integrated at an enterprise level as the start date for the new CECL standard approaches. Here, writing for CIOReview, Bart Everaert and Will Newcomer from Wolters Kluwer’s Finance, Risk & Reporting business in North America examine what’s at stake.
The American Bankers Association (ABA) has recently released discussion papers that suggest community banks may need to consider implementing the Financial Accounting Standards Board’s Current Expected Credit Loss (CECL) accounting standard earlier than initially expected. The standard, which goes into effect in 2020 for SEC registrants and 2021 for other banks, requires an estimate of expected credit losses over the life of the portfolio to be effectively recorded upon origination.
The issuance of CECL concludes a journey that began in the wake of the global economic crisis. During that time, the delayed recognition of credit losses associated with loans was seen as a weakness in the application of existing accounting standards, a factor that was determined to have contributed significantly to the financial crisis. As a result, the FASB began exploring alternatives that led to the use of a more forward-looking assessment.
Based on discussions with bankers, regulators, auditors, investors and FASB members, ABA’s papers question the prevailing assumption that CECL will necessitate few changes at community financial institutions, noting that bankers will need to contract d ata warehousing services to manage the related loan performance data, examine loan characteristics in whole new ways and acquire third-party peer data.
2018- A year for determining how to organize or reorganize finance, risk, reporting and IT people and processes at the enterprise level
But whenever the standards enforced it will be a game changer. Financial institutions will have to determine their allowance for credit losses in a different way, affecting not only accountants, but also loan officers, internal auditors, chief credit officers and, of course, IT personnel.
The new accounting procedures will no doubt force bankers to keep their eyes on the road ahead. And revising recognition of credit losses to include expected credit losses over the life of the loan will, in theory, achieve the integration that regulators have long sought and hoped the Comprehensive Capital Analysis and Review and stress testing would achieve.
An Altered Reality
But the question is–how will CECL alter the way in which banks conduct their business at an enterprise wide level? Arguably, the CECL standard will win the day for integration because it will be business as usual and disclosed through the income statement versus a once or twice a year exercise submitted to prudential regulators and receiving limited public disclosures.
CECL will require institutions to come up with their best estimate of credit impairments using their best predictions of the operating environment that they will face. They may supply much of this information daily. And the results will not be regarded merely as the outcome of a hypothetical exercise; they will be factored into the financial statements presented to regulators, the board, and investors and treated as a testament to their credit risk and capital management prowess.
As they set about implementing CECL, that prospect should force executives to contemplate another hypothetical: What if a model that is poorly thought out or poorly executed, or perhaps data management processes that are not up to the daily grind of CECL calculations, gets it wrong and generates provision forecasts that are too low or too high when regulators and the stock market demand that they be just right? With so much on the line, an institution’s personnel must work together as never before, with all functions, particularly finance, risk, and reporting, performing in concert.
Strengthening a Holistic Structure
Accordingly, they will need tools that are organized the same way, as a fully integrated solution that doesn’t just conform to the desired holistic organizational structure but strengthens it.
Together they can implement a CECL solution that is flexible, adaptable, consistent and, perhaps most important, durable so that it will be able to perform a range of complex operations simply and elegantly, and then perform them repeatedly.
Just how formidable a challenge an institution will face in putting CECL into effect depends substantially on how far along the road it has gone toward integrating key departments, particularly risk, finance and reporting, and following the other guidelines set by The Basel Committee on Banking Supervision and the accounting standards boards, such as adopting a more forward-thinking approach and greater flexibility in decision making.
If material progress has already been made in these areas, then preparing for the new standard will be mainly an engineering problem. Such well positioned businesses will have to upgrade and/ or reconfigure systems to calculate impairment allowances and their impact on the profit-and-loss statement, capital requirements, and other key metrics, and to produce the relevant disclosures for supervisory authorities.
For institutions that still have a compartmentalized, siloed organizational structure in place, a more thorough, comprehensive overhaul will be in order, and sooner rather than later. Enhancing communication and cooperation among a bank’s key functions is emphasized by regulators and accounting standard setters across the board.
Arguably then 2018 will, for many, be a year of determining how to organize or reorganize finance, risk, reporting and IT people and processes at the enterprise level to create the efficient, transparent, and repeatable systems and procedures for calculating expected credit losses.
Only those firms prepared to invest in the necessary technology infrastructure to aid them in these efforts will have any competitive advantage.