Garnet Capital Advisors Blog

EXCERPT: After the financial crisis that plagued the U.S. in 2008, the Financial Accounting Standards Board (FASB) established what’s known as the Current Expected Credit Loss (CECL) model, which requires that financial institutions reserve for life of loan losses at origination. This will, in turn, could entice banks to sell long-term assets in favor of purchasing short-term assets and the transactions will need to be carefully carried out with some guidance along the way.

Bank accounting is going through one of the most significant changes as a result of the implementation of the CECL standard as set forth by the FASB.

Following the financial debacle nearly a decade ago, a large part of the regulatory response in the U.S. has been centered on the need for financial institutions to adopt stress testing practices on their assets. A major overhaul in bank accounting took place with the Financial Accounting Standards Board’s (FASB) implementation of the Current Expected Credit Loss model, or CECL.

The new regulations will lead to a boost in banks’ allowance balances and may even result in increased volatility in provisions. Heading into the economic crisis, financial institutions' reserves were too low, partially because the accounting standards being used only identified losses when it was apparent that a borrower was going to default.

With the emergence of CECL, banks are being forced to analyze all information, including anticipating stress, in order to more accurately calculate reserves. The new standard is encouraging a shift from measuring reserves based on incurred losses to reserves that are based on proposed lifetime expected losses.

CECL Poses Challenges For Banks

The FASB's CECL model is causing great concern among banks across the country, not only because of the expected loss reserve amortized over the life of all financial instruments, but also because of the unknown effect that it may have on financial statements. What is known is that the CECL standard will place significant stress on financial institutions that have not yet resolved any existing issues with their data architecture.

As per the CECL, calculating reserves will now have to involve forward-looking information of reserves based on the anticipated losses over the lifetime of financial instruments.

Financial institutions may be required by the FASB to perform forward-looking inquiries into their loan portfolios and adopt specific processes that remain in compliance with the new CECL standard. The need to make these modifications to how banks handle their reserve processes will potentially complicate their operations, disclosures, and reporting. Banks will now need to have a more comprehensive understanding of their reserves and how they will change in the short- and long-term in order to maintain compliance.

Establishing CECL Compliance

Financial institutions have undergone significant and rapid change ever since the financial crisis hit the country back in 2008. Loans have been increasingly subject to stringent accounting standards and regulatory expectations. It’s crucial that financial institutions of all sizes and asset classes develop a resolution that can be implemented and integrated between departments that will provide accurate and current data that can be stored in one centralized location.

In order to be compliant with CECL standards, financial institutions must develop the capability of quickly and easily adapting to the current environment and accurately anticipate future losses over the life of a financial instrument. Streamlined processes and a solution that merges all data sources will help banks establish a far-reaching and inclusive overview of accounting and risk.

Banks that already have a robust loan loss allowance model will be able to more easily establish sound CECL frameworks built upon what they’re currently working with. Those with stress-testing capabilities and credit risk management models can use these as their launching point. 

Seeking Guidance From Loan Sale Advisors Amidst New Standards

It’s expected that loan-loss reserve balances can go up as much as 30 to 50 percent. The mix of banking products is also anticipated to change as the increase in lifetime allowance balances lean more toward shorter-term loan assets.

Banks should seek to employ available tools that will help them make more sound decisions and remain in compliance while optimizing their loan portfolios. They should also seek guidance on choosing the right approach and determining any potential implications.

The fundamental point of CECL is that banks will have to reserve for the life of loan losses at the point of origination which is expected to drive banks to sell longer-term assets and purchase short-term assets instead.

Garnet Capital has been helping financial institutions of various sizes in both the buying and selling end of loan transactions while remaining in compliance with heightened regulations and standards. Find out more about what Garnet Capital can do for your bank, sign up for our newsletter today.