Come January 2023, the Financial Accounting Standards Board’s CECL standards – Current Expected Credit Losses – will apply to any financial institution that issues credit. Is your bank or credit union prepared?

When CECL goes into effect there will be fundamental changes to the way institutions account for credit losses in their allowance for loan and lease losses. To ensure you’re ready for this change of accounting standards, lenders not already under CECL need to prepare now.  But don’t just aim for compliance. Let CECL regulations enhance your achievements and help you accomplish more!

To begin the preparation process for CECL, assess all your data. Your historical loan data is likely in a wide variety of platforms that will need to be standardized so your institution will be able to better leverage your existing data to calculate your expected credit loss under the new accounting standards.

When standardizing your data consider CECL requirements, go beyond sorting by loan type and duration. Consider data patterns that correlate historical data and macroeconomic factors, data CECL uses to find where portfolios are most sensitive. Segment your loan pools and document your rationale.

Once you’ve collated this data, don’t let your work go to waste! Continually scrutinize your loan portfolio using CECL to better understand the portfolio’s key risks and their potential impact. Monitoring credit trends and activity patterns can help you gather the knowledge you need to minimize credit loss.

Also, choosing the CECL methodology that best works for your institution is important. BakerHill lists CECL methodologies as cumulative loss rate, vintage rate, migration rate, and probability of default. The cumulative loss rate requires a qualitative analysis of a smaller amount of data collected in advance. The use of vintage rate is common for retail credit card and mortgage portfolios and tracks loan performance by given origination periods and historical economic performance indicators. For the migration rate method, you need to be able to track loan behavior through different classifications and detailed scenarios. Like migration rate, probability of default calculates the likelihood of loans experiencing default events by using historical trends with the added flexibility that makes its use effective for unpredictable loan pools.

CECL poses many opportunities, but to minimize challenges we need to begin the process early to prepare for compliant and effective implementation. Beginning to effectively leverage the new CECL accounting standards and the methodologies it offers can enhance your loan portfolio.