Five Questions for Bank Boards

Issued by the Financial Accounting Standards Board (FASB) in June 2016, the current expected credit loss model, or CECL, is one of the biggest accounting changes that the banking industry has experienced, as it replaces the current incurred loss model for estimating credit losses. The credit loss calculations under CECL will likely increase loan loss allowance levels, so boards should understand how the new standard will impact current strategies relative to growth and capital planning, says Chad Kellar, a partner at the advisory firm Crowe LLP.

The new standard takes effect for fiscal years beginning after December 15, 2019, for banks that file statements with the Securities and Exchange Commission or annual and quarterly reports with their primary banking regulator. For all others, the standard takes effect in the first quarter of 2021. Kellar and Tom Caragher, director of product management at ZM Financial Systems, weigh in on the questions directors should be asking about CECL.

1. Who is on our CECL implementation team?

The bank needs a team in place that represents all areas of the bank to move the project forward effectively, says Kellar. A project manager from the accounting or finance area should lead the team. In addition, the team should include members from the bank’s information technology department, given their understanding of the bank’s information architecture and how the data will be stored. There should be representatives who understand loan operations and credit risk, and the internal audit and risk management functions should be involved, as CECL implementation touches on financial reporting and internal controls, as well as model risk management.

The C-suite should also have representation on the CECL implementation team to avoid surprises later on, says Caragher. “Usually the CFO, because in the end they have to sign off on this, and they have to explain to the auditors and examiners-it’s more directly attributable to them now,” says Caragher.

And the accounting team should be represented, due to its understanding of the necessary disclosures that will need to be generated. “The disclosure side is pretty big, and thinking about how you’re going to model the analysis for banks, it’s going to be fairly simple, but it does require different data and more data,” says Kellar.

2. Does our bank have a handle on its data?

Since the data needed to comply with the CECL standard differs from the former incurred loss model, the executive team and board should discuss their data needs, if they haven’t done so already. “What data do we need, how much do we need, where is it coming from and where are we putting it,” says Caragher. Many banks won’t have enough data to accurately estimate loss rates-as much as 10 years worth of data is needed for longer-term loans. For banks that don’t have a long history of data, he recommends talking with the bank’s auditor and field examiner. If the bank’s making a good-faith effort to improve, that may be enough for now. If not, the bank’s call reports could be used to fill in the gaps. “[The banks have] the information,” says Caragher. “It’s just a matter of piecing it together, and that’s a little harder.” The information won’t be as granular as the bank will need later on, but it should suffice to fill in gaps in its data.

3. What methodology should we use?

After the executives and board understand its data, they should then determine which methodology best suits the bank, says Caragher. The most popular and simplest methodology is the snapshot or open pool methodology, which uses a snapshot of the loan portfolio at a point in time to calculate a lifetime historical charge-off rate. Growth-oriented banks may want to consider more complex methodologies, such as the vintage method, which calculates the lifetime historical charge-off rate based on a particular origination year, or the remaining life method, which uses the average annual charge-off rate and remaining loan pool balance to calculate the lifetime historical charge-off rate. Once a methodology is chosen, Caragher recommends running that in parallel with the bank’s current methodology before implementation, so the management team and board fully understand the adjustment due to CECL.

4. How will our risk profile change under the new CECL methodology?

New methods of analysis could change the board and management team’s view of the bank’s risk profile. “Do we understand how common measurements or metrics today may be viewed differently under a CECL methodology, and mean something different?” says Kellar. The board should also be aware of the information it is receiving about the bank’s loan portfolio, and understand that loan growth and credit risk ratings could be impacted differently under the new standard.

5. Does our bank need to invest in new technology?

New technology isn’t required, but you may discover that your bank needs to update its technology to properly store and analyze the data required. Organizations that have relied on Excel spreadsheets or an internal database may find that system insufficient under the new standard, or may worry about the potential for human error. “It might be worth the investment to have someplace reliable to store the data and access it with the calculations that are already verified independently,” says Caragher. But understand what your bank needs. “Analyze what you need, and don’t let people frighten you into spending hundreds of thousands of dollars,” he says.