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Credit impairment

The Financial Accounting Standards Board (FASB) issued the current expected credit losses (CECL) standard – ASU 2016-13 – on June 16, 2016. The FASB and the International Accounting Standards Board (IASB) worked to overhaul the current impairment models in the wake of the economic downturn. The new accounting standards will have a pervasive impact on all financial institutions (specifically banks) and applicable asset portfolios (e.g., loans, leases, debt securities). In response to the anticipated changes, affected institutions will need to assess their governance and risk management frameworks, credit models, data requirements, accounting and operational policies and procedures, processes, controls and IT systems to plan for successful implementation of the new requirements.

Please join us for Implementing the new credit impairment standard: Insights from US banks, a special edition of our Dbriefs webcast series, being held on March 9th at 2 p.m. ET. Click here to register. For more information, please also see the results of our latest US Current Expected Credit Loss (CECL) survey.

What are the credit impairment models under the FASB and IASB?

The FASB’s CECL model and the IASB’s IFRS 9 standard will be effective beginning in 2020 and 2018, respectively, if early adoption is not elected. Entities must understand the new requirements to position themselves toward compliance with these standards. 

Learn more about CECL:

Learn more about IFRS 9:

What is the effective date?

The FASB provided a long transition timeline (i.e., January 1, 2020, for calendar-year public business entities that are SEC filers, and January 1, 2021, for all other calendar-year entities). Early adoption is permitted for all entities beginning January 1, 2019.

The IASB issued its new impairment guidance as amendments to IFRS 9 in July 2014. IFRS 9, as amended in 2014, is effective for all entities for annual periods beginning on or after January 1, 2018. However, early adoption is permitted. 

What are some of the expected operational impacts?

Many of the modeling approaches that financial institutions currently use for Basel regulatory capital calculations, economic capital calculations, and for stress testing purposes can be leveraged and adapted for CECL/IFRS 9. However, in certain instances, new credit models will need to be implemented. The introduction of the new impairment standards has broad implications to an institution’s governance and risk management framework, credit modeling practices, processes, controls, and IT systems. All of which will require a well-thought-out tactical plan—spanning across credit modeling, regulatory compliance, IT and financial reporting. Considerations include:

  • Program management. Coordination among various stakeholders – finance, credit modeling, risk, IT, and others
  • Managing implementation to address intersecting reporting requirements – US GAAP, IFRS 9, CCAR, Basel, DFAST and internal reporting
  • Governance and risk management framework
  • Development of robust, well-documented data quality processes that provide details for extract, transform, and load (ETL) procedures as well as data quality scorecards or reports
  • Separation of loan-level characteristics to be used in modeling probability of default (PD) and loss given default (LGD) parameters, to align ALLL practices with Basel requirements
  • Portfolio segmentation with sufficient granularity to appropriately forecast expected credit losses
  • Credit risk modeling and forecast models and methodologies
  • Quantitative tools can be aligned and calibrated for use across the capital management framework to ensure consistency
  • End-to-end process redesign and control environment

 

Read our points of view on implementation of the new impairment standards:

Getting started

Identifying the intersection in requirements between financial and regulatory reporting and adopting a unified strategy for estimating expected credit losses that capitalizes on interdependencies will allow a financial institution to gain operational efficiencies and facilitate a lean implementation program. In addition, a well thought out integrated approach will lend itself to a consistent framework and is more likely to be accepted by auditors and regulators.

Credit Modeling
Whilethe analytical infrastructure required for CECL can be an extension of that which is currently employed for credit risk management purposes, the implementation of CECL estimates will have to be aligned with the upcoming accounting guidance. This effort will require coordination among the loan origination / credit risk / finance / analytics /compliance and reporting functions.  To estimate expected credit losses under CECL and IFRS 9, the modeling techniques and the allowance estimation methodologies currently used will likely need to be updated or replaced with more sophisticated estimation techniques. Learn more about Deloitte Advisory’s Allowance for Loan Loss (ALL) Optimization Suite and our Solvas | ALLL+ software.

Regulatory capital impact
Banks will have to consider the increase in their allowance on their risk-based and leverage capital ratios and amend capital plans, while also phasing in higher capital requirements as a result of the revised capital rules issued in 2013. In addition, higher provisions for loan and lease losses will impact the results of CCAR/DFAST stress testing. Learn more about our regulatory services.

Operational implications
Efforts to comply with the new credit impairment models will create downstream impact on an institution’s current business processes, control environment and operating model. Institutions will need to adopt a broad approach to end-to-end process redesign. For instance, the following can facilitate a lean implementation:

  • Multi-purpose processes and control points can be identified and leveraged to reduce the implementation and operational burden.
  • Dual-purpose definitions and classifications of both on and off balance sheet exposures can facilitate a holistic approach for balance sheet mapping and ongoing exposure identification activities.
  • Enterprise-level data warehouses and related activities, such as common data quality protocols, can simplify infrastructure design, reduce cost, and maximize operational efficiencies.

Financial and regulatory reporting impact
As an institution works to implement the new standard, it can capitalize on this opportunity to improve and build out its financial and regulatory reporting capabilities. The challenge of implementing standardized processes and reporting technologies that can satisfy multiple, complex financial and regulatory reporting requirements may be difficult and should be managed and addressed. Learn about our automated external reporting services.

Technology considerations
To support an institution’s allowance methodology, credit modeling and reporting requirements, the institution must carefully reassess the capabilities of its internally-developed and/or third-party technology. Learn more.

Solvas | ALLL+

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Jonathan Prejean

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Jonathan, a managing director for Deloitte & Touche LLP, provides advisory, accounting consultation, and audit support services for clients’ capital markets transacting activities and related accounti... More

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Peter Wilm

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Irv Bisnov

Banking Audit Leader

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