Impact of current expected credit loss (CECL) on the US financial institutions – An overview
Journal of Management Research and Analysis
Failure in the timely adjustment of the reserve levels based on reasonable anticipation of future conditions was turned out to be the major drawback of the Allowance for Loan and Lease Losses (ALLL) accounting standard during the great recession of 2007-2008. 1 The major issue during the time of crisis was that the unfavorable economic conditions was not taken into consideration for the calculations of losses under the ALLL method. Because of that reserves were not adjusted for the expected
... or the expected losses in the future. In 2011, The OCC (Office of the Comptroller of the Currency) and Fed (US Federal Reserve) anticipated that the allowances in the industry would increase by 30% to 50%. 2 But since the expectations of the economy has changed drastically since then, many economist have predicted that the increase in the industry allowances would not be significant. Keefe, Bruyette & Woods, Inc., an investment banking firm headquartered in New York City predicted in September 2015 that the median increase in ALLL for small and mid-size bank will be meagre 3%. 2 After the great recession, Financial Accounting Standards Board (FASB) reviewed how financial institutions are estimating the losses in the ALLL calculation. Various weaknesses in the existing incurred loss model (ALLL) were exposed, which included complexity and delay in recognition of credit losses. At the time of review, The FASB and the International Accounting Standards Board (IASB) discussed and proposed many approaches to correct the damage. Ultimately the final resolution was to make a new accounting standard altogether that should accelerate recognition of credit losses and CECL come into the picture. CECL requires the estimation of expected losses over the life of the loans, and is forward looking approach to make the allowances by giving consideration to the future economic outlooks and the life of the loan. The major expectation of the FASB while introducing this new standard -CECL is that it will improve the liquidity, stability and financial reporting of the financial institutions, and will necessitate the timey recording of credit losses on loans. After much discussions and review, the Financial Accounting Standards Board finally issued 'Measurement of Credit Losses on Financial Instruments' in June 2016, 3 which contained the methodology for the current expected credit losses (CECL) for estimating allowances for credit losses loans and other financial instruments. As per the CECL methodology, financial institutions requires a determination of the expected amount to be collected on a portfolio of originated loans from day one till the entire life of the loan. The day one CECL allowance would be equal to the difference between the originated loan amount and expected loan amount to be collected over the life of the loan.