Will CECL Help Prevent the Next Financial Crisis?

While there were many undeniably bad repercussions from the financial meltdown that occurred in 2008 and onwards, there were also some good results. One of these is the new credit losses standard that will be in effect December 2019. This new standard will impel financial institutions to change the way they analyze credit.

What is CECL?

CECL (current expected credit losses) is the new standard of accounting that is set to take effect in December 2019. In 2016, The Financial Accounting Standards Board (FASB) released (Topic 326), which is the Accounting Standards Update on Financial Instruments – Credit Losses. The CECL replaces the current loss accounting standards of FAS-5 and FAS-114 and will change the manner in which financial institutions record expected credit losses. According to this source, “the basis of the CECL requirement is to review loans that share similar risk characteristics on a collective basis, in order to add additional preventative measures on top of the changes already being made for recapitalizing banks and increasing emphasis on stress testing.” CECL changes the standards used for resolving balance sheet reserves for credit losses.

The changes will affect all public US SEC institutions that issue credit or hold financial assets and lease investments that are accounted for at fair value through net income. This will enact fundamental changes for estimating losses in allowances for loan and lease losses (ALLL).

How CECL Compares to the IFRS 9

The IFRS 9 is an international standard for calculating credit losses. The IFRS 9 measures expected credit quality changes in three stages for assets that are performing, assets that have substantial increases for risk of default and credit that is impaired. This measures credit losses over periods of time. In contrast, CECL requires loss calculations for all lifetime expected credit losses for assets in a single credit-loss measurement. According to this article, “IFRS 9 and CECL are similar in respect of their shifting to “expected” losses from “incurred” losses for the basis in provisions for impairments.”

Expected Impact From CECL

There will be a significant impact on financial institutions as they implement the new CECL. According to this business, “a major effect will be from the larger allowances that will be required for most products. Pricing of these products is expected to change as a result.” Data collection will need to become more granular, and modeling methodology will be focused to look forward over the life of the loan.

There is no doubt that the new CECL will change the manner in which institutions that deal with credit. This will inevitably affect consumers, but just how much will have to be determined after the new standard is implemented. Hopefully, this new way of judging the future of credit losses will have largely positive results from increased financial stability in the markets.

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