With the most sweeping re-casting of credit risk management in decades looming on the horizon, regulators, bank executives and the markets are bracing for the potential disruptive ramifications of this new set of credit loss accounting standards. In response to calls for a more cautious rollout, regulators have agreed to an implementation extension for most community banks.
While the extended timeline was welcomed by most institutions, many doubts remain about how banks can anticipate some of regulatory guidance still on the horizon. One resource you may not have considered is the Federal Register. For the uninitiated, the Federal Register is the daily journal published by the federal government which provides a public forum for regulators to post their legislative intentions. Among the concerns which have gained prominence among bankers are questions focused on exactly how examiners will evaluate for compliance with CECL standards.
A Closer Look at the Federal Register
As it turns out, the responsible regulatory bodies have shared updates to CECL principles and methodologies a few weeks ago in the form of ‘Interagency Guidance on Credit Review Systems’ which they published here in the Federal Register. Featured within this posting is an entire section which bankers may find interesting, entitled “Examiner Reviews of ACLs”.
A read through this section provides several interesting insights regarding what banks may expect from future CECL examinations. For example, the document clearly suggests that CECL programs will be subject to existing (if not augmented) model management guidelines. This is worth noting because it suggests a need for a greater level of rigor and transparency that some banks may not have been expecting.
Also, the document indicates that examiners will not (and should not) rely on past bank or peer benchmarks to establish reasonableness of CECL estimates. Nearly every banker we talk to has some concerns about how their ACL allowance under CECL may change relative to their current ALLL. They are understandably concerned about the impact to capital. But they are also concerned about the optics from an examiner’s perspective if ACLs appear substantially different than the current ALLLs. This portion of the Federal Register text provides some clarity for bankers– that examiners should have no predetermined range of acceptable CECL allowances for any given bank.
The text further supports this notion by indicating examiners should recognize the subjectivity of estimates relative to each individual bank’s loan pool and risk profile: “When assessing the appropriateness of ACLs, examiners should recognize that the processes, loss estimation methods, and underlying assumptions an institution uses to calculate ACLs require the exercise of a substantial degree of management judgment.”
A Feedback Loop for Regulators
Though the document is a bit cumbersome to read in its entirety, it’s worth spending a few minutes reviewing it, particularly if you have concerns about how CECL may impact your bank. Note that regulators are actively seeking feedback about these intentions (and others) via the following three questions outlined in this Federal Register document:
Question 1: To what extent does the proposed credit review guidance reflect current sound practices for an institution’s credit risk review activities? What elements should be added or removed, and why?
Question 2: To what extent is the proposed credit review guidance appropriate for institutions of all asset sizes? What elements should be added or removed for institutions of differing sizes, and why?
Question 3: What if any additional factors should the agencies consider incorporating into the guidance to help achieve a sufficient degree of independence and why? To what extent does the approach described for small or rural institutions with fewer resources or employees provide for an appropriate degree of independence in the credit review function? What if any modifications should the agencies consider and why?
Interested parties are encouraged to submit comments via any of the following methods by 12/16/19. You may submit comments via Regulations.gov online by going here or via email regs.comments@occ.treas.gov.
Tony Hodson is Senior Vice President of Market Data at OTC Markets Group. Tony leads QaravanSM, an integral part of OTC Markets Group’s suite of data products which are designed to provide intuitive risk & performance analytics on more than 5,000 U.S. banks to banking and financial industry professionals. Connect with Tony at tony@otcmarkets.com