Last month, I became buried in a multi-day Google binge; combing the web for things like “CECL Prep”, “CECL Requirements”, and “CECL Implementation”. I finally understand the Socratic Paradox.
A few thousand years ago, during a conversation with some guy in the neighborhood, Socrates concluded that neither of the men knew anything (they were talking about CECL, I think…). But Socrates was the only one that was willing to accept their mutual ignorance. And thus, the “Socratic Paradox” was born. By being aware of his own ignorance, Socrates apparently knew something. And this made Socrates at least a tiny bit wiser than the guy who knew nothing but still thought he had superior knowledge.
Like the ancient thinkers before me, I have been to The Google and I have found the universal truth of CECL: nobody really knows much.
Maybe you’ve come to this conclusion already. Like me, maybe you’ve googled for CECL and found a lot of recycled FASB text and timelines, but little in the form of practical guidance. I concluded my own research with not much more than a minor headache and some sales brochures disguised as “CECL implementation kits”.
To help sort through this, I thought it might be refreshing to get some perspective from a trusted third party with a decent reputation as a critical thinker. Socrates seems like a pretty reasonable “Honest Broker”, “Trusted Advisor”, or whatever phrase the consultants are using these days.
Below, I offer three truths of CECL discovered in the wisdom of Socrates.
- “The only true wisdom is in knowing you know nothing.”
The truth is, nobody can write the definitive, universal guide on CECL. The FASB rules were intentionally written rather loosely in an attempt to provide maximum flexibility for different types and sizes of institutions. The unfortunate side effect is that this flexibility has caused a lot of anxiety for the banking sector, which instinctively gravitates toward clear lines of compliance.
Also, consider that nobody on Earth (in ancient or modern times) has ever been through this CECL labyrinth before. There isn’t a single bank or vendor whose CECL model has been fully audited or examined yet. That doesn’t mean anyone trying to solve the CECL problem is a charlatan. It’s just a recognition that we’re all operating from the same limited set of information and we would be wise to recognize this.
The wide range of CECL products and services already on the market is a testament to American capitalism and entrepreneurship. It is also a good indicator that there is still a lot of room for what we could charitably call “artistic interpretation” of the FASB standards. Until we get through a few audits and examination cycles, Socrates might suggest that the industry dial back the FUD factor a bit, particularly that which may be directed at smaller community banks.
- “Knowledge is the kindling of a flame, not the filling of a vessel.”
Bank regulation is where Qaravan got its start and our clients include about ¼ of all US regulatory agencies. CECL is a topic we discuss with them often and there has been a significant amount of consensus on what regulators will be looking for over the next 2-3 years.
The two common themes we are hearing from chief examiners are:
- Regulators are not expecting a modest community bank to delve into complex discounted cash flow, vintage, or migration analysis. Most community banks will be well served by using some form of CECL’s simple and more familiar “cumulative loss rate” model.
- Regulators are not interested in playing a game of “CECL Gotcha!” in which they penalize banks for having immature or incomplete models. Instead, they are expecting a more collaborative and iterative approach that will allow banks time to organically improve their models as more experience is collected and clearer guidance can be provided.
To paraphrase a presentation by Michael Gonzales, Professional Accounting Fellow from the Federal Reserve Board of Governors, a thoughtful CECL ALLL model should consider three concepts:
- Unadjusted historical lifetime loss experience,
- Plus adjustments for past events and current conditions,
- Plus adjustments for reasonable and supportable forecasts.
There are also a few wonky accounting treatments your CFO should be familiar with (like how to handle Available-for-Sale Securities, for example), but otherwise, there is not a specific prescription for what the above three bullet points need to include. Depending on what data and analytical talent your bank has available, you may approach these three concepts from a different perspective than the bank down the street does.
It seems that’s just fine by regulators, as long as an informed analysis is performed and documented in good faith. The specific details of the analysis are largely left up to each bank to determine.
With CECL, the industry is trying to kindle the fire of a new analytical capacity, not just check the box on some regs.
Which leads to the third truth…
- “Beware the barrenness of a busy life.”
When it comes to CECL, most bankers I talk to don’t think the juice is worth the squeeze. It looks like a tremendous amount of administration with little in the way of payoff. I haven’t spoken to a banker yet that thinks CECL will help them return more to shareholders, attract new talent, or better serve customers.
Adding to this, the constant drumbeat bankers hear from industry is that CECL is going to be hard. Really hard. And they need to get started right away. There’s not a moment to lose. They’re probably already too late.
So, bankers feel like they should be doing something. And that something they’re doing (whatever it is) is supposed to feel arduous and painful, right? After all, it’s CECL.
But as it turns out, for smaller community banks, regulators, auditors, and bankers have a surprisingly compatible desire for a simple CECL implementation. Regulators are not seeking an exhaustive or complex model per se, but rather a model that is supported by sound assumptions. Similarly, auditors don’t expect banks to predict the future, but rather to methodically consider it and document their analysis.
Unfortunately, well-meaning consultants and vendors may have unnecessarily complicated things by creating complex solutions that don’t really scale down to the limited scope and capacity of smaller community banks. In fact, the Fed’s Gonzales is quite clear on this point as well: “Smaller and less complex institutions are not required to build costly or complex [CECL] models or hire third-party providers.”
In their search for the best CECL system, process, or model, many community banks are getting buried in the busy work and missing the bigger picture. The “best” model isn’t the one with the greatest number of inputs, the most complex algorithms, or the most technical jargon. For the vast majority of community banks, the best model will be the one that bank management can reliably maintain and explain. Beyond this, take the advice of Socrates and avoid the barrenness of a busy life.
To learn about Qaravan’s more user-friendly, intuitive approach to CECL, you can contact us at firstname.lastname@example.org.