The Federal Deposit Insurance Corporation (FDIC), Federal Reserve Board of Governors, Office of the Comptroller (OCC) and National Credit Union Administration (NCUA) have released a proposed Interagency Policy Statement on Allowances for Credit Losses intended to promote consistency in the interpretation and application of the Financial Accounting Standards Board’s (FASB’s) current expected credit losses (CECL) methodology (FASB ASC Topic 326).
The statement was accompanied by proposed Interagency Guidance on Credit Risk Review Systems.
In June 2016, FASB announced plans to replace the incurred loss methodology with the CECL methodology, with the goal of creating greater transparency of expected credit losses. The switch will take place over the next few years.
Larger, public financial institutions are required to implement CECL by January 2020, while smaller institutions—not-for-profits, private companies and certain smaller public companies—will now have until January 2023.
The proposed policy statement (which would be effective at the time of each institution’s adoption of the credit losses accounting standard) describes the measurement of expected credit losses; supervisory expectations for designing, documenting and validating expected credit loss estimation processes, including the internal controls over these processes; and maintaining appropriate allowances for credit losses (ACLs).
In addition, the proposal would update existing policy statements with regard to the responsibilities of management for the allowance estimation process to, among other things, maintain the ACL at appropriate levels, and of the board of directors to oversee management’s process as well as the role of examiners in reviewing the appropriateness of an institution’s ACLs as part of their supervisory activities.
The agencies requested comment on all aspects of the proposed policy statement, including whether it clearly describes the measurement of expected credit losses under CECL and communicates supervisory expectations for designing, documenting and validating the expected credit loss estimation process.
In the Interagency Guidance on Credit Risk Review Systems, the four agencies proposed to update existing guidance to reflect the CECL methodology and—in recognition that credit risk review systems have a broader application in risk management programs than just providing information on the collectability of an institution’s loan portfolio for determining an appropriate level for the ACLs—issue a stand-alone guidance document.
The guidance sets forth the objectives for an effective credit risk review system (including identifying loans with actual and potential credit weaknesses and identifying relevant trends that affect the quality of the loan portfolio) as well as attributes for an effective credit risk rating framework (such as identifying or grouping loans that warrant the special attention of management and evaluation of the effectiveness of approved workout plans).
The agencies asked for input on the guidance, with specific questions regarding to what extent the proposed guidance reflects current sound practices for an institution’s credit risk review activities and whether any additional factors should be incorporated into the guidance.
Comments on both proposals will be accepted until December 16.
To read the policy statement, click here.
To read the guidance, click here.
Why it matters
Adoption of CECL has been well-publicized and is poised to be a significant event for financial institutions, many of which have been preparing for years for full implementation. The policy statement and the guidance are an effort by the agencies to help financial institutions in their preparations for the transition to CECL methodology, updating existing practices to reflect the pending changes. And they should help in the preparations for those institutions that have until 2023 to implement CECL. For institutions that are required to implement CECL in 2020, however, the policy statement and guidance are too late to help with the preparations for the next safety and soundness regulatory exam.