FASB permits early adoption of CECL for fiscal years beginning after December 15, 2018, including interim periods within the fiscal year. The decision of whether to pursue formal early adoption is a complex one hinging on specific factors that vary among institutions. We are finding, however, that early implementation of a CECL solution offers many potential benefits regardless of whether an institution opts for early adoption.
The benefits of implementing a CECL solution comfortably in advance of adoption are analogous to those of a flight simulator. Both enable professionals to gain insights into how a new system functions and reacts to various influences in a riskless environment. Like a flight simulator, early CECL system implementation enables institutions to move forward with this important standard in a controlled and well-considered manner. It benefits institutions by allowing time for analysis and supporting optimal decision-making.
It accomplishes this in the following ways.
Enhanced Data Readiness
Data readiness is a crucial factor in CECL implementation. Analysts and risk managers need to know whether their data will be sufficient to support effective functioning of a credit loss forecasting model specifically designed for their portfolio. Early implementation facilitates answering this question in advance by enabling institutions to assess the following:
- Internal data completeness
- Internal data reliability
- Internal data accessibility
- Externally sourced forecasting elements
Data preparation often requires a considerable investment of time and effort that can span months. Obtaining data and developing interfaces to legacy systems and other sources requires planning and sufficient time to develop and test queries. Early implementation provides a safe environment for exploring data nuances and figuring out what works best.
Appropriate Cohort Segmentation
Loans and revolving credits are segmented into risk-related cohorts for credit loss forecasting purposes. Clients frequently ask whether existing segments should be revisited or revised in a CECL implementation. The answer, like most, depends on many factors. However, when new segmentation is called for, it takes time to analyze the effect of risk factors on losses and to devise the new segmentation strategy. That work would ideally begin well in advance of formal CECL adoption, along with testing methodologies for each segment.
Early Operational and Internal Control Insights
Capturing the real-time data necessary to book lifetime losses at origination will pose new and daunting challenges. Traditional ALLL processes historically enabled banks to largely ignore originations occurring near the end of an accounting period. CECL changes all this by requiring day-one losses to be booked upon origination, thus potentially taxing data collection processes that likely will need to be streamlined in order to gather the data necessary to produce loss forecasts in time for the accounting close.
In addition to overcoming the obvious operational obstacles associated with this degree of data processing, early implementation gives banks an advance opportunity to assess the internal controls issues that will inevitably arise. Datasets and models that previously were not subject to SOX and financial reporting control testing may need to be reviewed in a new light. Controls around the databases and models supporting the life-of-loan calculation will almost certainly need to be enhanced to meet financial reporting expectations. Figuring out how to address all this in the relative safety of an early-implementation simulator is preferable to learning it on the fly.
Capital and Strategic Planning Benefits
Because CECL is generally expected to increase loan loss reserves, the effect on bank capital should be understood as soon as possible. Banks will want to understand the potential impact of CECL on capital to inform discussions with the board, auditors, regulators, and shareholders and to factor into capital planning in advance of formal adoption.
It is particularly important for banks that are active in mergers and acquisitions to understand the implications of CECL on earnings. This will inform efforts currently underway or planned for the next couple of years. Early CECL implementation also provides the ability to begin making lending and origination decisions informed by CECL.
Compared with the relatively complex decisions surrounding whether to pursue early CECL adoption, deciding whether to implement a CECL solution early is straightforward. Regardless of whether a bank opts for early adoption, early implementation promises a range of benefits that will support optimal risk management decisions going forward, regardless of when CECL is ultimately adopted.
