Allowance for loan losses
In the aftermath of the financial downturn, there has been an increased level of scrutiny on the estimation of a financial institution’s allowance for loan losses. This point of view discusses the complexities associated with operationalizing the accounting and regulatory requirements related to your allowance for loan losses, and the steps you should start to take prior to implementing the Financial Accounting Standards Board’s new credit impairment model (i.e., the current expected credit losses model).
The complexities and challenges
It is often complex for a global institution to gain visibility into its exposure to credit risk, particularly if its operations are decentralized or managed using multiple financial reporting systems and dissimilar processes. Operationalizing accounting and regulatory requirements, as well as changing methodologies underlying existing credit models, continue to be challenging. In addition, banks must elevate their standards for governance and risk management to meet increased regulatory scrutiny and formal expectations set by the Federal Reserve Board, Office of the Comptroller of Currency, and Federal Deposit Insurance Corporation.
Change is on the horizon
The Financial Accounting Standards Board (FASB) is expected to issue its new credit impairment standard describing the current expected credit losses (CECL) model during the first quarter of 2016. The CECL model will likely affect most financial institutions and applicable asset portfolios (e.g., loans, leases, debt securities) by requiring those affected institutions to estimate their allowance for loan losses (ALL) based on expected losses rather than incurred losses. Although the effective date is currently undecided, it will likely be no earlier than 2019.
Because the amendments will affect an institution’s current processes for estimating ALL and recognizing other-than-temporary impairments on applicable debt securities. Financial institutions should consider reevaluating their current capabilities related to the estimation of ALL, particularly in light of the FASB's soon-to-be-issued credit impairment standard.
Driving performance through enhanced capabilities
Banks require a comprehensive framework and methodology for estimating ALL. A holistic approach provides an opportunity to assess current capabilities related to allowance methodology, internal processes, credit modeling, and regulatory and financial reporting to leading practices. In addition to developing a baseline for future transformation activities, taking a fresh look at current capabilities can result in recognizing synergies from using a holistic and integrated approach for estimating ALL.
There is no better time than the present to reevaluate current capabilities related to the estimation of ALL, particularly in light of the FASB's soon-to-be-issued credit impairment standard. With a holistic approach and an integrated framework described above—financial institutions can enhance their current capabilities related to estimating ALL while fulfilling US GAAP and regulatory requirements and simultaneously laying the foundation for implementation of the CECL model.
- Putting current expected credit losses (CECL) in perspective
- Allowance for loan lease losses CECL: The road ahead with the CECL approach
- Practical insights on implementing IFRS 9 and CECL: ASU 2016-13 and opportunities for implementation efficiencies
- Additional CECL-related information can be found on our credit impairment resource page
Learn more about CECL
Download the publication to explore more about the proposed CECL model and anticipated implementation challenges, as well as some ways organizations can use CECL model implementation as a catalyst to align accounting impairment and regulatory capital processes.