Danielle Sesko
With Current Expected Credit Loss (CECL) requiring institutions to estimate and
recognize credit losses upfront, financial leaders must navigate a complex new
landscape as this shift could significantly impact loan portfolios, regulatory compliance
and long-term strategies – creating potential hurdles for financial institutions. Despite
these bumps along the way, CECL also offers the chance for more accurate risk
management and faster decision-making, harnessing its potential to strengthen
operations and financial resilience for both borrowers and lenders alike.
The history of CECL
The Financial Accounting Standards Board (FASB) issued ASU 2016-13 to amend the
guidance on the impairment of financial instruments. This amendment introduced the
CECL model, which shifts the approach for recognizing credit losses from an incurred
loss model to one based on expected losses. In essence, financial institutions must
proactively recognize potential credit losses, rather than waiting until a loss is probable.
According to Deloitte’s 2024 edition of On the Radar: Current Expected Credit Losses,
the primary CECL objectives of CECL are to reduce the number of credit impairment
models used for debt instruments, and to enable the timely recognition of credit losses.
By adopting an expected loss model, CECL aims to address potential losses before they
occur, rather than relying on the previous practice of waiting for evidence of actual
loss.
The CECL model also requires financial institutions to recognize an allowance for lifetime
expected credit losses, ensuring a more proactive approach to credit risk
management. One of its key features is it does not mandate a specific method for
estimating these expected losses, allowing institutions to choose an approach that
works best for their unique circumstances.
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At its core, CECL represents a significant change in accounting regulation that directly
impacts the financial statements of institutions. By requiring them to recognize losses
earlier and more accurately, CECL affects everything from profit margins to risk
management strategies, making it critical for financial institutions to adapt to these new
standards.
New and evolving pressures
Financial institutions are still grappling with the need to allocate more capital to cover
potential credit losses. This shift has placed additional strain on capital reserves for
institutions, creating a situation that mirrors the challenges faced during the previous
liquidity crisis. However, unlike the liquidity crisis, which primarily focused on cash flow
issues, the current concern is a capital crisis – marked by rising costs of capital and
declining deposit levels.
Coming at a time of economic uncertainty, when institutions are already managing
pressures such as fluctuating capital costs and reduced deposits, the demands of CECL
have made it even more difficult for financial institutions to adjust. This has highlighted
the complex relationship between regulatory changes and broader economic cycles,
making it harder for institutions to respond effectively to the new requirements while
navigating ongoing financial pressures.
The role of technology in reserve requirements
As the implementation of CECL continues to hit institutions hard, forcing them to post
larger reserves, there is a growing interest in how innovative technologies and payment
protection solutions could ease the financial strain and help reduce the burden of
these increased reserve requirements.
One effective approach that many institutions are starting to embrace is the
implementation of an embedded payment protection strategy. This could allows
lenders to help reduce charge-offs and loan delinquency risks, which could negatively
impact their bottom lines and create major strain for borrowers. This type of strategy
could also help combat these challenges by offering borrowers a safety net during
times of financial hardship, such as unexpected expenses due to sudden job loss or
disability, to lower the likelihood of default.
Such an approach can also help improve the accuracy of credit loss estimates by
proactively addressing potential risks before they materialize. By reducing the number
of loan delinquencies and defaults, financial institutions could better predict and
manage their future credit losses, helping them stay compliant with CECL’s more
stringent requirements.
Along with mitigating financial risk, it is also crucial for financial institutions to remain
well-tuned with information security and public safety. As institutions navigate CECL
compliance, secure systems and transparent communication are important to help
protect both the lender and its borrowers. The implementation of a payment protection
strategy helps ensure that financial institutions remain well-equipped to handle the
challenges posed by CECL while safeguarding the financial well-being of borrowers.
And, if a financial institution is putting together its loan loss methodology and
calculations, the institution could leverage a payment protection strategy and the
performance that they have had with it to set their reserves. However, financial
institutions should always consult with their auditors and accountants, determining how
to apply these laws and regulations for their specific institution.
The combination of payment protection solutions, like debt protection, credit insurance
and TruStageTM Payment Guard Insurance, with a robust framework for managing credit
losses could significantly enhance the ability of financial institutions to comply with
CECL, helping them reduce risk and safeguard the financial wellbeing of borrowers. This
approach may be able to not only provide a clear path through the capital crisis and
the complexities of CECL but could also strengthens institutions’ postures to remain
resilient against economic and regulatory pressures.
TruStageTM Payment Guard Insurance is underwritten by CUMIS Specialty Insurance
Company, Inc. CUMIS Specialty Insurance Company, our excess and surplus lines
carrier, underwrites coverages that are not available in the admitted market. Product
and features may vary and not be available in all states. Certain eligibility requirements,
conditions, and exclusions may apply. Please refer to the Group Policy for a full
explanation of the terms. The insurance offered is not a deposit, and is not federally
insured, sold or guaranteed by any financial institution. Corporate Headquarters 5910
Mineral Point Road, Madison, WI 53705. © TruStage
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