Many banks are unprepared for changes in accounting standards next year on how to calculate losses on their loans and leases, according to a new survey.
The survey, by the financial information company Sageworks and SourceMedia Research, polled 236 banking and credit union executives with a role in credit risk management who are also subscribers to Accounting Today’s sister publication American Banker. The results indicated that the majority of banks are not currently prepared to meet the requirements of a proposed model from the Financial Accounting Standards Board, which would mandate how banks calculate their allowance for loan and lease losses, or ALLL, a balance-sheet reserve for expected credit losses.
A significant share of credit risk managers indicated little to no familiarity with the model expected to be adopted by FASB, according to the survey. The survey found that manual processes, which may not be enough for handling the complexity of the new model, are prevalent in most banks’ current calculations of the ALLL.
When they were asked about their current method for calculating their financial institution’s ALLL reserve, 65 percent of the survey respondents said they used spreadsheets. However, Sageworks pointed out that spreadsheets are often prone to errors and problems.
Many banks are also awaiting the finalization of the FASB’s Current Expected Credit Loss, or CECL, model, before making substantial modifications to their current processes. The proposed FASB CECL model takes a “life of loan” approach to the ALLL calculation, requiring banks to book loan losses for the entire duration of the loan at origination. This is expected to increase banks’ reserve levels by 30 to 50 percent from the current standards.
In addition, the new model could require 1,000 times more data, increasing the difficulty and complexity of the calculation. The survey found that many institutions are currently using processes that may be unable to accommodate the increasing data requirements and complexity.
However, 37 percent of those surveyed are not familiar with the CECL model, indicating a lack of preparation and understanding of how the plan would impact their current method of determining the reserve.
Among the survey respondents who are familiar with the expected accounting standards changes, 34 percent said their institutions would wait until the CECL model is finalized before implementing an automated solution. Only 12 percent already have software that complies with the new model’s proposed requirements.
“With the impending changes all but imminent, banks should be upgrading their processes and practices to capture a vast amount of data at the loan level,” said Ed Bayer, managing director of the financial institutions division at Sageworks, in a statement. “Capturing this data dynamically, archiving the data at each month’s end and making it accessible will be crucial for defensibility and to limit subjectivity under the new model.”
In late July, the International Accounting Standards Board decided to change its previous incurred loss model, which will differ from FASB’s approach. European banks and others that use IFRS outside the U.S. will have to record 12 months of expected losses for all loans, and will have to immediately account for lifetime losses if there is significant deterioration in the risk of a loan after the loan is made.