News & Insights
Mar 30, 2020
The Federal banking agencies recently issued an interim final rule (Regulatory Capital Rule: Revised Transition of the Current Expected Credit Losses Methodology for Allowances) permitting banks to mitigate the effects of the current expected credit loss, or CECL, accounting standard.
Introduced in 2016 by the Financial Accounting Standards Board, CECL replaces the incurred loss methodology for financial assets and requires banks to recognize lifetime expected credit losses. Specifically, banks would be required to incorporate reasonable forecasts when estimating lifetime expected credit losses, while also requiring banks to consider past events and current conditions.
Widely recognized as one of the most sweeping changes to bank accounting principles ever, CECL poses significant compliance and operational challenges to all banks implementing CECL.
In February 2019, the Federal banking agencies issued a final rule that revised the agencies’ regulatory capital rule, stress testing rules and disclosure requirements to reflect CECL as well as amended other regulations referencing credit loss allowances. Acknowledging the potential adverse effects of CECL on banks’ regulatory capital ratios, however, the agencies included a transition option to phase in any such negative effects over a three-year period. The agencies intended for the transition period to address concerns that unexpected economic conditions could result in higher-than-anticipated increases in allowances at the time of CECL adoption by a bank.
Given the uncertainty regarding the magnitude of the effects of COVID-19 on the U.S. economy, the agencies’ interim final rule provides an alternate option for banks to temporarily delay the effect on regulatory capital (e.g., the increase in the allowance for credit loss under CECL relative to the increase in the allowance for loan and lease losses under the incurred loss methodology) attributable to the adoption of CECL. Specifically, banks that adopt CECL during the 2020 calendar year are permitted to delay for two years the estimated impact of CECL on regulatory capital, followed by a three-year transition period to phase out the aggregate capital benefit provided during the initial two-year delay. Meanwhile, banks that have already adopted CECL may elect either the three-year transition period under the 2019 CECL final rule or the five-year transition option under the interim final rule beginning with the First Quarter 2020 Call Report or FR Y-9C.
The relief provided by the agencies is intended to be operationally simple for banks to implement, to reduce banks’ compliance burden, and to better enable banks to focus on supportive lending activities to creditworthy customers, while enabling banks to maintain the desired level of quality of regulatory capital during these especially uncertain economic times.
For any questions or additional information, please contact Kevin Tran at (615) 850-8743.
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