July 13, 2018, marks the comment deadline for the federal bank agencies’ proposed capital rules amendments to grant all banks the option to elect a three-year phase-in of the “day 1” regulatory capital effects from adopting the new and burdensome FASB Current Expected Credit Losses (CECL) methodology under GAAP (scheduled to become effective for the first group of banking organizations in their first fiscal year beginning after December 15, 2019). Critically, the election to use the three-year phase-in approach would be required to be made by the end of the first regulatory reporting period in which the banking organization applies CECL, otherwise it is forfeited. The proposed three-year phase in period affords community banks with much-needed time to plan and test for CECL implementation thereby easing some of the CECL anxiety community bankers are experiencing.

CECL’s Requirements

The federal bank agencies’ proposal would also make amendments to stress testing regulations so that covered banking organizations would not utilize the CECL methodology for purposes of stress testing until the 2020 stress-test cycle. Under CECL, the existing “probable” threshold in GAAP is removed and banking organizations will be required to impair their existing financial assets based on an allowance for expected credit losses. Under CECL’s aggressive loss recognition model, the banking industry could be paying several times over for the same potential future losses, even though those losses may never be incurred.

New CECL Systems and Valuation Models

Under CECL, bank management would be required to incorporate complex and more forward-looking information in reporting on credit losses. Banks will be required to make an increased investment of significant time, manpower, and financial resources to change their accounting and reporting systems to collect the type of data that will be required to estimate prospective losses. From an operational standpoint, massive changes in bank core information operational systems will be required throughout the country.

CECL’s requirements will require a much greater degree of analysis and a much higher cost to administer. The currently-available loan accounting systems do not have all of the capabilities necessary to handle the nuances and variables that will be required for banks to comply with CECL’s requirements, particularly on such a large scale. The current methodology utilizes a historical loss model which, if applied correctly and supplemented by adequate disclosures, is a more accurate model to determine loan loss reserves. But under CECL, this practice will not be permissible. Major systems revisions and/or new financial and risk systems will be required to comply with CECL. The development of these new systems and models will require an enormous investment and significant amounts of time and resources to implement across the financial services industry without significant benefit for the users of financial statements. The lack of systems capability will present significant operational challenges and risk for banks.

Banks are currently preparing to add a forward-looking component to their allowance-for-loss calculation, gather and retain the data used to build and test models that work for them, and discuss the new system with independent auditors to confirm agreement with the planned calculation. New information will be required for footnote disclosures in financial statements and will need to be extracted from banks’ data-processing and core systems, and arranged in the proper format. They would also need to consider forecasts of future losses, as well as using available current and historical data.

The development of all these new systems and valuation models will require an enormous investment and significant amounts of time and resources to implement across the financial services industry without significant benefit for the users of financial statements. It’s been argued by some that the hundreds of millions of dollars that will be spent by banks to acquire systems and implement a multitude of new processes to comply with CECL’s requirements will far exceed any benefit. The tremendous resources needed to accomplish this could dwarf the nominal, and arguable, value of the information derived, thereby failing the cost/benefit criteria of most sound rulemaking. The significance of the transformations of existing accounting and credit risk management systems required to implement CECL should not be underestimated. Banks are expected to experience a reduction in retained earnings as a result of adopting CECL and they need alternatives to suffering adverse impact to regulatory capital. Some even believe CECL may hurt the economy and bank stock valuations, without any improvement in the reliability and relevancy of financial statements.

Final FASB CECL Rules More Flexible for Community Banks

In spite of the foregoing serious concerns, the FASB CECL rules appear now more flexible and scalable than originally proposed in 2011, and hopefully will allow community banks to continue using their personal understanding of their local markets—instead of complex modeling systems—to determine their loan-loss reserves. Allowing community banks to evaluate and adjust their loan-loss amounts using qualitative factors, historical losses and current systems has been essential to preserving the community banking model itself. As originally proposed in 2011, the CECL model would have imposed a one-size-fits-all approach designed for homogeneous pools of commoditized loan products.

Community banks are likely to oppose any impairment model for portfolio loans and investment securities that would increase costs and regulatory burdens for them. The initial version of FASB’s CECL model would have required small community banks to use complex cash flow modeling to generate expected losses over the life of the loan or security. Such modeling would have required community banks to dedicate valuable resources to model selection, testing, production, and maintenance in addition to extensive data sourcing, warehousing, and administration. This expenditure of resources would have limited community banks’ potential for loan growth and constricted economic expansion in local communities.

Fortunately, in its final version of the standard, FASB determined that smaller institutions should be allowed to utilize existing processes to project future credit losses. These include spreadsheets, narratives, and other noncomplex estimation efforts. Bank regulators have expressed a willingness to accept forward projections of future losses using these existing tools and process as well. It is imperative that community banks play an active role in the implementation of the final standard to ensure regulators honor FASB’s view of it and do not require small community banks to implement complex modeling techniques.


For larger community banks and those that choose to adopt a cash flow modeling approach, modeling inputs should not be more difficult to source, maintain, and apply than is warranted by the underlying risks being identified and measured. Unfortunately, absent formal regulatory guidance, “best practices” with regard to model inputs that may be appropriate for larger institutions may become de facto requirements for community banks. Community banks are encouraged to seek experienced bank regulatory counsel to assist them in navigating the complex requirements of CECL as it poses significant compliance and operational challenges for them.

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