The Financial Accounting Standards Board (FASB) recently passed a groundbreaking update to its leading guide, covering everything from credit to savings institutions and holding companies. One of the biggest updates is in regard to Current Expected Credit Loss (CECL). CECL ushers in a new era of transparency, accountability, and responsibility. The sweeping changes across financial risk management may require teams to dive deeper into asset analysis. But what exactly is this new update and what do you need to know about CECL?
What is CECL?
CECL, or the Current Expected Credit Loss standard, was released in June of 2016. It represents fundamental shifts to loan and lease loss allowance models arising out of FAS-5 and FAS-114. It is the result of the evolution of ‘incurred’ to ‘expected’ losses on commercial assets held by financial entities. The increase in balance sheet reserves remains the focus of regulators and supervisory boards in finance. This new standard promises to highlight how a global economy can protect itself from systemic risks.
When do we use CECL?
Financial institutions hold the majority of credit assets, leaving them most exposed to balance sheet losses. They are in the business of originating and finalizing the distribution of loans to other institutions and individuals. The ultimate expectation of which is repayment, which a large percentage are ultimately repaid with interest. Inevitably, however, when default occurs then losses tend to follow. Accounting practices prior to 2008 helped exacerbate its effects by delaying preventative action even in the latter stage of the crisis. There are nine qualitative factors that apply in CECL, making it preferable to the old ways despite accompanying challenges.
What’s the Goal?
The endgame is how to better recognize the inherent credit risks that underscore assets on a financial institution’s balance sheet. Additionally, it is to provide an enhanced view of the instrument’s future condition. Banks, unions, funds, and equity firms can take a better position when examining the strength of their portfolios. Risks can be segmented and viewed based on both the historical and the present. As well, relevant information that will most affect that particular pool of assets is considered. Origination is the key point in time in the life of the loan. The CECL update provides clearer procedural handling of debt securities, data methodologies, third-party management, and weighted average maturity estimation. Bridging discretionary gaps is one of the many benefits of the plan proposed by experienced accounting practitioners around the world.
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