CECL Delay Opportunity for Strategic Risk Process Improvements | Wolters Kluwer
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  • CECL Delay Opens Window of Opportunity for Strategic Risk Process Improvements

    by Will Newcomer, VP – Business Development & Strategy, Wolters Kluwer

    Published September 02, 2019

    The prospect of a delay in implementing the FASB’s new CECL (Current Expected Credit Losses) accounting model has been lauded by many industry practitioners and observers keen to see the emerging standard modified or repealed. But it appears that under the proposed “two-bucket approach”, much of the former Wave 1 institutions will remain to be compliant by 2020, making it imperative for financial institutions to continue apace with their preparations.

    And while the proposed second bucket, which now includes all former Wave 2 and 3 and smaller reporting companies (SRCs), will almost certainly be pushed back to 2023, this gives these institutions the opportunity to optimize their approaches to the regulation.

    The FASB’S latest proposed Accounting Standards Update (ASU) would grant private companies, not-for-profit organizations, and non-SEC filing public companies additional time to implement CECL, and encouraged stakeholders to comment on its proposal by September 16. As such, it appears likely that the decision to delay CECL, whose original specification was issued by the FASB in June 2016, will be ratified within the next two months.

    To date, industry concerns about the CECL standard have been focused on a limited portion of the CECL process, with a focus on two of its six major steps. Specifically, these relate to CECL’s requirements around economic forecasts and the ECL calculation itself which is expected to create unnecessary volatility. Whether that’s the case is open to debate, but it’s nonetheless important to note that most core elements of the process are consistent with current industry best practices and therefore worthy of implementing regardless of CECL’s final form.

    Furthermore, it’s clear that auditors and regulatory examiners have accepted the remaining four of CECL’s six steps (Data Management and Process Governance, Credit Risk Assessment, Accounting, and Disclosure and Analytics) and will not ignore them in future audits and exams. Financial institutions that choose to keep their pre-CECL process for these steps do so at their own peril, falling behind competitors, or increasing costs in a late rush to compliance. Instead, strategically minded institutions are forging ahead with those aspects of CECL that have been identified as consistent with best practice.

    With a delay from FASB looking almost certain, institutions can move forward with confidence in their strategic plans for risk management, regardless of the final form CECL takes. Accepted wisdom suggests that firms should continue work on improving their capabilities in risk and finance, leveraging the work they’ve already completed while addressing the fundamental challenges in complying with CECL. They should monitor industry and regulatory developments in this space, particularly during this period of uncertainty, to keep abreast of how best to prepare for dealing with CECL or whatever comes next.

    As the marketplace pauses ahead of the FASB’s guidance on CECL next steps, financial institutions have a unique opportunity to move beyond the contentious areas of the CECL calculations and focus on creating strategic benefit by adopting positive elements of the standard. By building on the best practices elements of the standard, firms’ investment in CECL to date can be leveraged to create business value in a number of ways.

    First, by adopting CECL practices they can improve their risk assessment and mitigation strategies, and grow the business while balancing risk and return. But more widely, institutions can align execution across the organization, at the same time engaging management and shareholders.

    Further to these tangible business benefits, institutions can use their CECL preparations to establish end-to-end credit risk management framework within the organization. By taking this approach, financial institutions can enjoy strategic, yet incremental improvements across a range of functions, improving decision making and setting the stage for preparations for future standards.

    This can yield benefits in a number of areas:

    Data management and quality – Firms starting to build their data histories with credit risk factors now can improve their current ALLL (Allowance for Loan and Lease Losses) processes and ensure the successful implementation of CECL when it comes into effect. Financial institutions frequently underestimate the time and effort required to put in place the data and data management structures required, particularly with respect to granularity and quality. The message is: for higher quality data, source data now.

    Integration of risk and financial analysis – This can strengthen the risk modeling and provisioning process, leading to improved understanding and management of credit quality. It also results in more appropriate provisions under the standard and can give an early warning on the potential impact of compliance. Meanwhile, improved communication between the risk and finance functions can lead to shared terminologies, methods and approaches, thereby building governance and bridges between the functions.

    Analytics and transparency – Firms can run what-if scenario analysis from a risk and finance perspective, and then slice and dice, filter or otherwise decompose the results to understand the drivers of changes in performance. This transparency can then be used to drive firms’ business scenario management processes (see below).

    Audit and governance – Firms can leverage their CECL preparations to adopt an end-to-end credit risk management architecture (enterprise class and cloud-enabled) capable not only of handling quantitative compliance, but also able to address qualitative concerns, enabling institutions to better answer questions from auditors, management and regulators. This approach addresses weaknesses in current processes that have been discovered by audit and regulators.

    Business Scenario Management – Financial institutions can leverage the steps detailed above to identify the impact of CECL on their business before the regulatory deadlines, giving them competitive advantage as others try to catch up. By mapping risks to potential rewards, firms can improve returns for the firm.

    Given the last month’s issuance of the ASU, the FASB will likely offer its guidance on CECL within the coming weeks. Notwithstanding any delay, firms can benefit from CECL best practices now, since they are equally applicable to the current incurred loss process. By implementing them now, firms can continue to build on their integration of risk and finance, improving their ALLL processes as they do. At the same time, institutions can build a more granular and higher-quality historical credit risk database for the transition to the new CECL standards, whatever the timeframes. This ensures a smoother transition to CECL, regardless of the form it ultimately takes, minimizing the risk of nasty surprises along the way.

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