CECL: managing implementation through collaboration

CECL: the movie

The accounting standard Current Expected Credit Loss (CECL), which requires banks to calculate expected credit losses and incorporate resulting provisions into its P&L statements, necessitates a flexible, adaptable technology solution that will enable closer collaboration among finance, risk and reporting functions.

Will Newcomer, VP of product and strategy, and Bart Everaert, market manager, risk and finance, Wolters Kluwer in the Americas, examine what a suitable technology solution for banks impacted by the standard looks like.

The deadline to CECL, the equivalent protocol from the Financial Accounting Standards Board (FASB) for predicting the extent and impact of credit impairments, is determined by a business’s fiscal year, whether it is a Securities and Exchange Commission (SEC) filer and whether it meets the definition of a public business entity (PBE). It will be the first day of the fiscal year beginning after 15 December 2019, for financial companies that have publicly held equity and that meet the definition of a US SEC filer (1 January 2020 for calendar-year entities). All others will have a year after that to get the job done.

That means the leaders of institutions that adhere to US GAAP will have to start thinking about the changes they will need to make between now and then to their technology and their activities overall. If they run global enterprises that answer to the FASB and IASB in different jurisdictions, moreover they are likely to find that the race to implement IFRS 9 has been merely the first of two heats.

CECL: the movie

Whereas other supervisory frameworks provide a snapshot of an institution at one or a few points in the year, CECL is more like a movie that tells the story of its life, warts and all. Especially the warts, in fact, considering the extreme provisioning procedures under the lifetime-loss rule.

It’s not an obscure art house film that few people will ever see, either. CECL calculations involve forecasts and educated guesses, but this is no mere what-if exercise. The results will determine real-world provisions and therefore real-world profits under ordinary operating conditions.

Compliance with the standard, therefore, is akin to producing a documentary, albeit one where viewpoints are often presented as facts, and not a fictionalised account. It’s one that will be scrutinised by a wide and influential audience – in the boardroom, at agencies like the Fed and the SEC, and on Wall Street – that will not hesitate to offer judgments on an organisation’s management, particularly regarding its use of capital.

CECL will require institutions to come up with their best estimate of credit impairments using their best predictions of the operating environment that they will face. They will have to supply much of this information daily. And the results will not be regarded merely as the outcome of a hypothetical exercise; they will be factored into the financial statements presented to regulators, the board and investors and treated as a testament to their credit risk and capital management prowess.

As they set about implementing CECL, that prospect should force executives to contemplate another hypothetical: What if a model that is poorly thought out or poorly executed, or perhaps data management processes that are not up to the daily grind of CECL calculations, gets it wrong and generates provision forecasts that are too low or too high when regulators and the stock market demand that they be just right? With so much on the line, an institution’s personnel must work together as never before, with all functions, particularly finance, risk and reporting, performing in concert.

Speaking with a common voice

They should be of like minds and speak with a common voice. And they will need tools that are organized the same way, as a fully integrated solution that doesn’t just conform to the desired holistic organizational structure, but strengthens it. The need to be right, right at the start and in the most efficient and economical – in time and money – way, means that institutions should put their best people on the job. They, in turn, will need the support of specialists that offer the best technology, experience and expertise.

Together they can implement a CECL solution that is flexible, adaptable, consistent and, perhaps most important, durable so that it will be able to perform a range of complex operations simply and elegantly, and then perform them repeatedly.

Just how formidable a challenge an institution will face in putting CECL into effect depends substantially on how far along the road it has gone toward integrating key departments, particularly risk, finance and reporting, and following the other guidelines set by the BCBS and the accounting standards boards, such as adopting a more forward-thinking approach and greater flexibility in decision making. If material progress has already been made in these areas, then preparing for the new standard will be mainly an engineering problem. Such well positioned businesses will have to upgrade and/or reconfigure systems to calculate impairment allowances and their impact on the profit-and-loss statement, capital requirements and other key metrics, and to produce the relevant disclosures for supervisory authorities.

For institutions that still have a compartmentalised, siloed organizational structure in place, a more thorough, comprehensive overhaul will be in order, and sooner rather than later. Enhancing communication and cooperation among a bank’s key functions is emphasised by regulators and accounting standard setters across the board.

The need to heed that advice may be most acute, however, when it comes to implementing CECL.