By Lauren Smith, CPA
Industry experts are calling CECL one of the most significant changes for financial institutions. Some have even gone so far as to hail CECL the “biggest change – ever – to bank accounting.” Nonetheless, the Financial Accounting Standards Board (FASB) and banking regulators assert that institutions will be able to leverage current risk management and reserving practices as a basis for implementing CECL. To help, we’ve outlined 8 considerations for your transition to CECL.
- Establish a framework for evaluating potential approaches – Estimating expected credit losses will be highly subjective. Estimation methodology decisions should not be made in isolation as estimation approaches will have consequences for reporting, systems, and data; which will need to change to support the methodology elections. Estimation methodology approaches should also be considered in conjunction with the size and level of sophistication of the institution and tailored to the institution’s portfolio diversity, business goals, and risk appetite.
- Define the target state – Narrow the scope of the CECL gap analysis by focusing initial efforts on defining the target state – i.e. identifying the areas of management judgment and the respective methodology elections.
- Identify compliant estimation methodologies and establish initial preferences – If you are not sure where to begin the project, begin by identifying the tasks that will require the most management judgment. Identifying and evaluating the areas of subjective judgment will be the most time consuming process and will require a significant time commitment from the team. More details on team requirements here.
- Document the rationale for evaluating methodologies – Institutions will be required to document and explain the rationale behind their methodology choices to auditors, regulators, and investors. For example, if a less sophisticated approach is taken for some portfolios, the documentation of the rationale behind why a more sophisticated approach was not chosen will prove to be a valuable reference long after the implementation project has been completed.
- Perform the gap analysis – This will help you identify current processes that can be leveraged, necessary updates, and to-be-built functionality which will serve as the basis for the implementation roadmap. It will also give you a better idea as to the level of effort and investment required for the transition.
- Consider the implications for reporting and analytics – Reporting and analytics will be more important than ever, and each methodology election will have consequences for reporting and analytics. For example, CECL does not specify a top-down or bottom-up approach; however, it may be difficult to identify the drivers of the change in expected credit losses when using a top-down approach.
- Organize and integrate data and systems – None of the concepts discussed above are possible without valid, accurate, and integrated data. The data challenge is twofold: the identification and availability of the right data and the integration of data across disparate systems.
- Be prepared for an iterative process – Industry practices and auditor recommendations are still emerging and will continue to emerge after 2020. Initial positions on the target state may change as the cost and level of effort to implement are discovered. As always, maintaining flexibility of your approach will be key throughout this process.
For more details on each of the tips above, check out our white paper, A practical guide to beginning the transition to CECL. And be sure to visit CECL.com for additional resources to help with the transition to this accounting standard.