Rapid Ratings Blog

Begin CECL Planning Now: IFRS 9 May Help Banks to Prepare

Posted by Rapid Ratings on January 13, 2017

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As U.S. banks begin 2017 with a countdown to their transition deadlines on CECL, they will soon realize the analytical and administrative challenges that lie ahead. The FASB’s Accounting Standard Update No. 2016-13, commonly referred to as CECL (Current Expected Credit Loss), resembles in scale and complexity of what larger banks faced with CCAR and DFAST, but it will burden a much larger audience than CCAR and DFAST ever will.

Industry experts at Infoline’s CECL Summit last month stressed that no depository, regardless of its size, can fail to have a working group of accounting, compliance, credit, tech and other executives in place in 2017 to begin addressing CECL requirements.  During the event, many banking professionals expressed growing concern over the availability of the resources and logistics necessary for implementing CECL. They are primarily troubled by the daunting task of accounting for expected losses over the entire life of the loan. The exercise appears to be implausible to many of them when it comes to healthy borrowers, especially C&I borrowers.

To Meet CECL’s Deadline, Banks Must Begin Now

While the 2019 deadline for reporting under CECL may seem far off, such metamorphosis of process will take years of planning and preparation, starting now. In the meantime, these are the3 Steps to Take Now Towards CECL Preparedness:

  1. Identify what exactly the financial institution needs to do to comply
    The immediate imperative for many banking executives is to clarify how much of their present methodology will serve them in complying with CECL and what more they will need to develop themselves or obtain from third parties to meet the new requirements.
  2. Ensure efficacy and the ability to integrate new tools
    As financial institutions identify their model-expansion needs, executives will have the ongoing imperative of subjecting new tools to rigorous validation not just of efficacy but also of consistency with previous modeling still in the bank’s employ.
  3. Establish Comprehensive Reporting to Operationalize Assessments
    Bankers will likewise have to secure workflow solutions commensurate with CECL’s new demands for collecting, analyzing, reporting and storing their loan data.

Bank executives at the Summit also expressed concern about how far out banks could plausibly claim to make their “reasonable and supportable forecasts” of expected loss. Larger banks anticipate using PD x LGD formulas in the C&I loan book. Many of them expect to spend large amounts of time and effort assembling the historical default statistics they need for CECL’s reversion interval at the back end of loan tenors, wherever banks decide they can’t forecast the time frames on their own. However, even the biggest banks represented at the Summit said they had not kept all the default information over time that CECL would require them to use.

Using Lessons Learned from IFRS 9 to Prepare for CECL

While most U.S. banks are still in the beginning stages preparing for CECL, a select few are positioned ahead of the rest. Global banks are set to become “dual reporters” of their Expected Losses, filing both under CECL in the U.S. and under IFRS 9 elsewhere. IFRS 9, which is the non-U.S. version of CECL, was made final in 2014 and takes effect in January 2018. While challenged to file under two standards, global banks have benefited by taking elements from their IFRS 9 planning to guide them through eventual CECL implementation.

The urgency that comes from IFRS 9’s rapidly approaching effective date serves CECL-preparation needs in several ways.  It forces dual reporters to adopt the forward-looking loss-estimation frame of mind. It forces them to bring together diverse staff who are unaccustomed to working together. It forces them to upgrade data assembly and storage, along with many other systems. It forces them to organize portfolios according to new reporting imperatives. It forces them to prepare appropriate communication strategies for critical constituents– board members, shareholders, the equity research community, rating agencies and the financial press– who will need to understand the sudden impairments to capital and earnings that are sure to come. It forces them to consider how such profound accounting changes will, in turn, change well-established business practices.

Shaping up for IFRS 9 and, especially, for CECL will likely be the highest priority and the most arduous challenge for the banking industry in 2017 and well beyond.

Topics: Regulatory Compliance, CECL