Allowance for loan losses

​​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.

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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.

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​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.

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​Next steps

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.

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