Putting current expected credit losses (CECL) in perspective
Fundamentals of implementation success
To address the consequences of the financial downturn and resulting stakeholder concerns, the Financial Accounting Standards Board proposed an update to current US Generally Accepted Accounting Principles (GAAP). The FASB’s proposed ASU, Financial Instruments—Credit Losses (Subtopic 825-15), would bring about the following changes to overcome the perceived shortcomings of current GAAP: expected loss approach over life of loan, elimination of the “probable” threshold, forward-looking approach, and reduced complexity.
We are pleased to present the second publication in a series that highlights Deloitte Risk and Financial Advisory’s point of view about the significance of the FASB’s update, ASU 2016-13–Measurement of Credit Losses on Financial Instruments, and related implementation considerations.
Anticipated implementation challenges
In September 2015, Deloitte Touche Tohmatsu Limited (DTTL) released the results of its fifth global IFRS banking survey (the Survey), with a focus on the implementation efforts around IFRS 9, Financial Instruments, and FASB’s CECL model.
The respondents indicated the following anticipated implementation challenges:
- Clarity around acceptable interpretation of the IFRS 9/FASB CECL model externally
- Necessary level of coordination between finance, credit, risk, IT, and others to execute the implementation
- Availability of data
- Capability to design, build, and test new models with limited internal resources
- Capability to plan and execute a program of this size in parallel with other current initiatives
With respect to the external stakeholder interpretation of FASB’s CECL model, the banks are intently following the regulators’ commentary related to the proposed GAAP changes. Several questions arise in this context, including whether the sector should anticipate certain regulatory-to-GAAP differences (e.g., on treatment of TDRs) and whether certain items scoped out of the CECL model would default to legacy guidance in ASC 450 (e.g., cancellable loan commitments) for regulatory or financial reporting purposes.
This point of view discusses the challenges described above that are within an entity’s control.
Roadmap to future state
To stay ahead of this evolving landscape, institutions need an integrated framework for estimating ALL that encompasses current accounting standards and regulatory views while simultaneously laying the foundation for the future.
In light of this, entities should consider:
- Benchmarking themselves against leading practices in estimating the ALL
- Evaluating existing impairment methodology, accounting, and regulatory policy decisions based on GAAP and existing regulatory requirements
- Identifying additional data required for modeling and new disclosures and seeking opportunity to leverage data competencies from regulatory processes
- Reviewing existing ALL estimation models to identify appropriate changes to methodologies to enhance functionality
- Evaluating the framework currently used to estimate the ALL and the corresponding regulatory and reporting processes to identify areas for efficiencies and leading practices
- Assessing current capabilities of internally-developed and third-party technology to identify necessary system changes or upgrades
Transforming a challenge into an opportunity
A change program of this magnitude calls for a strategic approach with clear-cut program management and defined roles and responsibilities. Further, given the broad nature of the implementation across the organization, senior management should be engaged around the strategic importance of an effective implementation and the critical milestones and challenges in the implementation roadmap.
As a final thought, more than 85 percent of the respondents to the Survey conducted by DTTL noted that they plan to use IFRS 9/FASB’s CECL model implementation as a catalyst to align accounting impairment and regulatory capital processes. It is evident that the changes in the impairment model will challenge current practice, but will also present opportunities for improving the financial position and business processes of the organization. The key is to plan ahead.
- Staying ahead: Allowance for loan leases
- 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.