CECL - The new FASB accounting rule to capture expected credit losses
Piyush Srivastava
Partner & Head - North America, BFSI Industry Advisory Group at Tata Consultancy Services
In June 2016, FASB unveiled a guidelines for the banks to capture the credit loss by taking into account the expected credit losses over the expected lifetime of the products, and not use the 40 year old “Incurred Loss Model.
Background of the new Current Expected Credit Loss Model (“CECL”)
In 2011, the FASB and the International Accounting Standard Board (“IASB”) partnered to improve and standardize guidelines for impairment losses in both U.S. GAAP and International Financial Reporting Standards (“IFRS”). They proposed a “three-bucket” model for reporting impairments.
What is the difference in the IASB IFRS 9 regulation and FASB CECL regulation?
IFRS-9: How does IFRS recognize impairment of assets in a forward looking expected credit loss model
IFRS divides the loan and subsequent accounting in three buckets namely:
CECL: How does FASB recognize impairment of assets in a forward looking expected credit loss model?
Calculation of the Probability of Default:
How do we calculate the Probability of default (PD): Old Paradigm vs. new approach
In Conclusion, CECL / IFRS 9 is About Improving the Measurement and Reporting of Credit Losses
The Expected Credit Losses are based on three main components:
· Historical loss data about the loan and borrower ratings
· Current loan related data and the current borrower rating
· Loan Loss forecasts under reasonable and supported scenarios and taking at Weighted average expected loss from these scenarios
Banks will have to design reasonable stress scenarios and calibrate their losses based on these scenarios and document them well. A bank is allowed to assign the weights to different scenarios, depending upon their qualitative understanding of the loan and the borrower rating
Banks need to well document and justify their rating methodology and approach to regulators.
Welcome to the new accounting requirement CECL!
Sounds like a game changer as it affects the basis for all credit risk management.