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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