Implications of the Current Expected Credit Loss accounting model

William C. Handorf ()

Journal of Banking Regulation, 2018, vol. 19, issue 3, No 2, 221 pages

Abstract: Abstract The Financial Accounting Standards Board approved a controversial accounting change in 2016 that impacts how and when US banks account for loan losses. The accounting modification will require the allowance for loan losses to be sufficient to cover all losses projected over the life of loans and leases originated or purchased. The standard is known as the “Current Expected Credit Loss” (CECL) model. Prior to the revision, banks established a reserve once there was evidence of a credit problem sufficient to incur a loss, and provided an allowance judged sufficient to cover losses over the subsequent year for unimpaired loans. Industry and regulatory agencies project the new accounting standard will require banks to establish an allowance higher, perhaps much higher, than presently required. CECL does not specify a model for banks to estimate losses but does require the results reflect economic stress. Accordingly, we apply a Basel II/III risk-based capital model for long-term mortgage loans stressed to the 99.9% confidence level for the largest US banks to estimate the upper bound of losses. The change in GAAP will not necessarily require a significant increase in the allowance for the average bank predicated upon the model adopted. The accounting shift only impacts unimpaired long-term loans, which are of better quality than classified advances. Further, most acquisition, development and construction loans, and commercial and industrial business credits mature within a year and expected loan losses already had been considered over their remaining lives.

Keywords: Forecasting (E27); Regulation (G18); Banking (G21); Accounting (M41) (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1057/s41261-017-0047-y

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