CECL: A solution in search of a problem
As a banking professional for more than 40 years, I'm baffled at comments by the head of the Financial Accounting Standards Board, which show a clear disconnect from the reality that community bankers are facing with one of the most significant changes to accounting standards in recent memory.
FASB Chairman Russell Golden recently said that the primary reason for the new current expected credit loss, or CECL, standard is to give more information to potential investors and stakeholders; and that investors favor CECL.
However, a recent survey conducted by the investment house Janney (then FIG Partners) indicated that 75% of bank investors opposed CECL. Even accepting Golden’s premise, he neglected to say that a majority of U.S. banks are not publicly traded, which means those banks should not be subject to the CECL standard meant for publicly traded firms.
It is interesting that Golden said “the board believes the benefits justify the cost.” The FASB was required to do a cost benefit analysis, but didn’t.
There are certainly a few costs that come to mind: the reduced availability of credit in the next economic downturn; the increased cost of credit to consumers and small businesses; the additional cost to buy a house; the yet-to-be-determined additional reserves required for Fannie Mae and Freddie Mac; and additional operational costs for all financial institutions.
All of these costs will be passed on to the consumer. This sounds like a benefit for investors on Wall Street, at the expense of people on Main Street. How can anybody conclude that the benefits justify the cost, when we don’t know what the cost will be?
Golden also does not mention that the additional procyclicality of CECL would lessen the availability of credit to those most in need during the next recession.
Generally, lending is a greater part of a smaller bank’s business than it is for large institutions. This means that smaller institutions are likely to be hit the hardest during the next recession by this incoming standard.
The CECL standard could be devastating to thousands of small-business owners who mostly rely on their local community bank for lending. Especially in a recession, small-business owners will need their local banker to work with them instead of facing delays because of the immediate impact CECL has on financial statements.
By requiring banks to account for the expected lifetime losses of a loan at the time of origination, there will eventually be shorter maturities on loans. This will result in more economic volatility, placing swings on the back of the consumer.
Consumers and small businesses will, in turn, be more hesitant to borrow because of the uncertainty of credit availability and greater interest rate volatility. This will particularly hit any consumer with marginal credit history. And many loans will simply move to the shadow banking sector, where federal regulators have limited purview.
I fundamentally disagree with recognizing credit loss expense at the time of booking the loan, while not recognizing the interest income earned on the same asset until much later. In other words, this standard forces an undeniable understatement of the bank’s capital and assets.
Golden does point out that FASB has given smaller institutions a longer time to implement the standard and is considering further delay. I’m glad that he is finally recognizing the massive efforts needed and that there are costs involved.
However, even for the small institutions it is still the same pain, just delayed. But the cost of each employee’s time to compile information, manage third-party vendors, data feeds and modeling will be significant and be passed on to the consumer.
The standard also tries to justify itself by saying that there is diversity in the current practice of incurred loss methodology. But the various "suggested" methods in the standard guidance show a diversity in results, even when using perfect foresight or hindsight.
When examiners come into my bank, our justification for doing everything has to be rock solid. We can’t tell them something and then say we disagree with our justification later, when it doesn’t fit the narrative.
From a practical application, CECL effectively "regulates" the adequacy of the loan-loss reserves for the financial institutions, taking responsibility from the federal and state banking regulators.
As a bank examiner from 1978 through 1988, I saw firsthand the recession of the early '80s and was responsible for overseeing the closing of several insolvent banks. While I held it to be a very sad and sickening situation, there were lessons learned by examiners, who realized what was important in analyzing credit risk and loan losses.
Those processes have continued to improve since the 2008 recession. Today, the examiners require bankers to properly justify their reserves, as they should. The current process and reserve levels have improved significantly and are working quite well, even before CECL’s implementation.
It is clear that this standard is a solution in search of a problem. It should be scrapped immediately.