After the financial crisis in 2007-2008, the Financial Accounting Standards Board (FASB) decided to revisit how banks estimate expected credit losses. Expected credit losses are recorded in the general ledger account named allowance for loan and lease losses (ALLL). The FASB and the International Accounting Standards Board (IASB) agreed that the way ALLL’s were being calculated prior to the financial crisis delayed expense recognition for credit losses and contributed to the financial crisis of 2007-2008 (Golden, Siegel & Schroeder, 2016). To help prevent future financial crises, the FASB began studying how to change the accounting standards so that a better way of accounting for credit losses could be used. After much research and many discussions with accountants, auditors, stakeholders, bank officers, and company managers, the FASB issued the current expected credit loss (CECL) standard on June 16, 2016. Under CECL, banks are to use historical experience, current conditions, and reasonable and supportable forecasts to calculate estimated credit losses (Golden, et al., 2016).
The current expected credit loss (CECL) standard took effect in June 2016 and will be fully implemented by 2020. CECL requires banks to use the new CECL standard instead of the incurred loss method. The incurred loss method assumes that the outstanding loans are going to be repaid until the occurrence of a trigger event causes the accountant to record the loan asset at a lower value. With the new CECL standard, banks must assume a more forward-looking approach and reflect all estimated credit losses on financial statements on the loan origination date (www.fasb.org). Loan loss reserves (LLR) are entries made by banks to cover estimated credit losses. Increases in the balances of LLR accounts are called loan loss provisions. Decreases in the balances of LLR accounts are called net charge-offs. The new CECL calculation increases the LLR balance, resulting in a decrease in net income and less profit. Therefore, some banks opposed the new CECL standard fearing that it will lead to an increase in bank losses (www.fasb.org).
The FASB’s proposed current expected credit loss (CECL) standard increases a bank’s loan-loss reserves, thus it also decreases a bank’s net income resulting in bank losses. Since it is not known whether banks could absorb the losses brought about by the CECL, a controversy about whether the new CECL standard should be imposed developed (Golden, et al., 2016).
The FASB wants the new CECL standard to take effect to decrease the likelihood of another financial crisis. Also, investors favor the new CECL since it gives them more informative financial statements, reflecting future predictions of expected losses. On the other hand, some bank managers do not want the CECL because it is expensive to implement (McLannahan, 2017). They also fear that the CECL will negatively affect company profits. Some smaller community banks oppose the new standard because they lack the complex information technology and big data capability of larger banks. Big data capability is needed to calculate the expected loss and smaller banks are at a disadvantage (McLannahan, 2017).
Although controversial, FASB’s proposed current expected credit loss (CECL) standard was issued in 2016 and is currently planned to be fully implemented by 2020. When the new standard is fully implemented, it will increase a bank’s loan-loss reserves and decrease net income resulting in less profit (Golden, et al., 2016). Whether bank managers could curtail the losses brought about by having to comply with the new current expected credit loss (CECL) standard is still unknown.
Golden, R., Siegel, M., & Schroeder, H. (2016, June 16). http://www.fasb.org (News Release 06/16/2016). Electronic media: Why a New Credit Losses Standard? Video retrieved from http://www.fasb.org/cs/ContentServer?pagename=FASB/FASBContent_C/NewsPage&cid=1176168232900www.fasb.org
McLannahan, B. (2016). US banks chafe at new loan loss rules. Financial Times. June 20, 2016. Retrieved from https://www.ft.com/content/f94bd13e-34d4-11e6-ad39-3fee5ffe5b5b