How New CECL Regulations Will Impact Credit

As a result of the 2007-2008 financial crisis, the Financial Accounting Standards Board (FASB) has issued a new standard on how financial institutions that lend money must report anticipated losses associated with those loans. Instead of relying solely on historical information, banks will now need to anticipate loses over the life of a loan, considering changes in economic climates. The new calculation and reporting requirement is called current expected credit loss (CECL). Although calculated losses under this new model are expected to be higher, it is anticipated, but not yet determined, that the impact will be less credit that the banks have to offer to customers.

Changing How Loss is Calculated

Simply stated, the new calculation estimates anticipated loss on a loan over the life of the loan, and the old calculation looked at a loss based on historical experience and only if the loan was most likely to be in default. Of course, the bankers themselves are working to understand how to make the new calculations and what effect they will have on bank bottom lines and operations. Other support groups are also providing recommendations. According to Visible Equity, it is recommended that banks treat a balance on a credit card as a closed-end loan with the lifetime being the amount of time it would typically take to pay off the balance. With some flexibility on the part of the industry, auditors, clients, and other stakeholders, more experience with the new requirement should contribute to a more accurate understanding of loan losses.

Impact on Credit Accessibility

Many people are concerned that once CECL goes live, loans will become more difficult to get. According to Banking Journal, bankers and other professionals agree; they believe that CECL will result in less credit being available to customers and that the credit that is available will be more costly. Furthermore, in times of economic downturns, even less credit is likely to be available, which means that small lending institutions will be hurt the most.

A Deviation From Fundamental Accounting Principle

The matching principle is one of the foundations of modern accounting systems. It calls for the expenses that are associated with the generation of revenues to be booked in the same accounting period as the revenues. By requiring that one of the costs associated with a loan, the loss of non-payment, to be booked when the loan is granted, causes a mismatch with the revenue from the loan, the interest, that is booked over the life of the loan as it is earned. This aspect of “non-matching” causes CECL to be more conservative than required to satisfy current accounting standards. 

As do most financial reporting changes, CECL has its controversies. Over time, the requirement could be tweaked to improve the desired visibility into loan losses without imposing undesired burdens on the industry and its customers.

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