CECL: A Competitive Advantage vs. Regulatory Burden
Referred to as one of the biggest changes ever to bank accounting, CECL, which takes effect in 2020, will require financial institutions to calculate the expected loss over the life of each loan and set aside reserves to cover those losses at the time of origination. It is projected that the industry may be forced to increase its reserve levels by as much as $246 billion, about 1.5 times more than reserve levels under the current model.
As a result, institutions are concerned with how this could impact capital requirements and their net income, not to mention the burden it will place on them to calculate expected loss. On the other hand, CECL presents a significant opportunity for financial institutions to achieve profitable loan growth objectives while remaining competitive through any economic environment.
CECL Will Encourage Greater Data Acquisition and Analytics
While this change may threaten a financial institution’s income, there are ways to minimize that risk. To do so, financial institutions will want to predict expected loss as accurately as possible. This will require sufficient data and robust analytics capabilities to help account for future economic conditions that may impact portfolio performance, over the life of its instruments.
Though CECL does not begin to take effect for some institutions until next year, all financial institutions should begin analyzing and preparing their data now in an effort to identify and correct any data gaps, as well as ensure accessibility and accuracy of its data for CECL compliance. Doing so will be a necessity in helping to limit risk and adhere to the standard. Building out this data will also prove advantageous as it will enable banks and credit unions to gain a more clear view of their risk.
CECL Will Drive More Optimized Origination Processes
CECL will also encourage institutions to review their loan origination process and identify areas in need of improvement. While this may be a challenge, it will provide institutions a more accurate view of how changes in risk exposure influence a loan’s performance. Financial institutions must consistently monitor data points captured at origination to determine when a change in credit quality has occurred, thus reducing the impact of an anomaly – such as an inconsistently decisioned loan on an entire portfolio’s performance and its loss allowance.
By gaining a solid understanding of the risk profile associated with their products as it is being decisioned and priced, financial institutions can gain a better understanding of the profitability of their various products and lending segments. In turn, they can make better decisions and better segment loans to support greater profitability.
CECL Will Allow Financial Institutions to Segment Loans and Drive Growth
By gaining a more clear view of the risk profile of their loan portfolio, financial institutions can better segment their portfolio, to gain deeper insights on the performance of the individual segments and what influences their performance. To do so, institutions must look at segmenting loans based on their performance through economic cycles, over the life of the loans. This process will take dedicated time and effort, but the long-term advantage will be an improvement of a financial institution’s ability to segment loans based on performance and identify portfolio trends. This will enable financial institutions to better determine risk and increase profitability.
CECL will bring significant change to the lending industry, but it also provides an opportunity for financial institutions to improve pricing in order to achieve profitable loan growth while still remaining competitive.. CECL will offer financial institutions an opportunity to change how they use data to decision and monitor loans, as well as what types of products they should offer. Additionally, financial institutions can use this data to gain a better understanding of the risk associated with their portfolio segments and develop more advantageous pricing models to drive profitable loan growth across lending segments. If approached as a competitive advantage versus a regulatory burden, CECL could prove advantageous.
Posted on Friday, March 15, 2019 at 3:00 AM
by Rob Foreman
Rob Foreman is a solution consultant with over 10 years of practical experience in the finance and banking industry, and serves as Baker Hill's subject matter expert for CECL. Rob has had broad experience in banking working on high visibility projects, serving both commercial credit and finance as well as accounting areas. Between his experience as an analyst and his responsibilities for the reserve/ALLL process, he brings a true life of loan appreciation to the solution consultant role.
Rob received his Bachelor’s in Finance from Illinois State University and his MBA from the University of Illinois. Rob’s first foray into the technology industry was during his MBA’s global consulting program where he served as consultant to a tech incubator in South Africa.