The current expected credit losses (CECL) accounting model was introduced by the Financial Accounting Standards Board (FASB) with an implementation date of January 2020 for U.S. Securities and Exchange Commission (SEC) large reporting companies. While the adoption in 2020 for large financial institutions was effectively delayed until the end of the year, still with an effective date of Jan. 1, 2020, many entities did adopt in the first quarter. CECL will be effective January 2023 for all other entities, smaller public business entities and nonpublic business entities. That extension for adoption provides smaller financial institutions not only more time for adoption, but also an opportunity to learn from their early adopting peers.
During the third quarter, DHG hosted a CECL Roundtable, which included executives from community banks in Virginia, Maryland and Pennsylvania, in order to discuss concerns and questions about the transition to the CECL model. The following ideas were shared during the virtual roundtable as the top five considerations for future CECL adopters.
1. Conduct multiple parallel runs
The goal of a parallel run is to ensure your institution is ready to report on CECL within the expectations of the board, management, external auditors and regulators. The first implementers noted that they wished they had more time to run in parallel, including running the model through stressed scenarios. They recommended that parallel runs include performing full internal controls and management reviews of the model to ensure all stakeholders are aware of the process. Institutions should plan for at least two quarters of full parallel runs prior to implementation.
2. Stress the model with extreme, negative forecasts
Using extreme negative forecasts can help identify situations in which model output may vary from expectations or uncover limitations of the model. The unique events of the COVID-19 pandemic revealed that not all models performed as expected during an actual period of high stress. First adopters were also not prepared for rapidly changing economic forecasts, and those not using a subscription service struggled to obtain updated forecasts that were available to the public. Some of the model outputs may have required adjustment with qualitative factors. During the model development and post-implementation, institutions will need to be certain they are providing an effective challenge of the model by stressing the inputs and assumptions. If the results are not consistent with the institution’s expectations, then the model may need to be further calibrated, or qualitative factors may need to be applied.
3. Complete model validation early and remediate findings
Allow enough time to make changes to the model based on feedback received from the validation report. Many institutions were still working on their model validation comments well into the first quarter. It is important to be prepared for a model validation by completing the internal model documentation prior to the start of the process so that the model validation team can perform a comprehensive validation exercise in an efficient manner. In addition, institutions should allow for sufficient time to remediate any findings prior to implementation. Therefore, first adopters recommend allowing for adequate time to develop, validate and remediate the model prior to implementation. This will promote a smoother and more efficient validation of the model.
4. Inform all stakeholders in a timely manner
Implementation is not solely isolated to the accounting and credit departments. Therefore, remember to inform all members of senior management and the board regarding the process and key assumptions well before going live.
5. Plan for changes to other processes impacted by adoption (regulatory capital, deferred tax, etc.)
Be aware of the impact CECL adoption has in other areas, such as regulatory capital rules, which provide an option to phase in the initial regulatory capital effects, with the relief period depending on an institution’s particular facts and circumstances. The interim final rule provides banking organizations that adopt CECL during the 2020 calendar year with the option to delay for two years the estimated impact of CECL on regulatory capital, followed by a three-year transition period to phase out the aggregate amount of the capital benefit provided during the initial two-year delay (i.e., a five-year transition, in total). The interim final rule does not replace the current three-year transition option in the 2019 CECL rule, which remains available to any banking organization at the time that it adopts CECL. Banking organizations that have already adopted CECL have the option to elect the three-year transition option contained in the 2019 CECL rule or the five-year transition contained in the interim final rule, beginning with the March 31, 2020, Call Report or FR Y-9C.
If you have questions or want to learn more about CECL, contact us at email@example.com.
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