RALEIGH, NC, (August 12, 2014) -- Despite accounting standard changes on the horizon later this year, the majority of banks are not currently prepared to meet the requirements of the proposed model, which will mandate how banks calculate their allowance for loan and lease losses (ALLL). This insight is derived from a survey sponsored by Sageworks, a financial information company, regarding financial institutions’ plans and their current process for calculating the ALLL, a balance-sheet reserve for expected credit losses.
The survey uncovered three primary findings that shed light on financial institutions’ readiness for the impending changes:
• Manual processes, which may be insufficient for handling the complexity of the new model, are prevalent in current calculations of the ALLL.
• A significant share of credit risk managers indicated little to no familiarity with the model expected to be adopted by the Financial Accounting Standards Board (FASB).
• Many banks are awaiting the finalization of the FASB’s Current Expected Credit Loss (CECL) model before making substantial modifications to their current processes.
The recent study surveyed executives in credit risk management at U.S. banks and credit unions.
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. Additionally, the new model could require 1,000 times more data, increasing the difficulty and complexity of the calculation. Sageworks’ survey found that many institutions are currently using processes that may be unable to accommodate the increasing data requirements and complexity.
When asked their current method for calculating their financial institution’s ALLL reserve, nearly two-thirds – 65 percent – of respondents said they used spreadsheets. Spreadsheets are prone to errors and are often sources of problems when examiners are present.
While it may not come as a surprise that many financial institutions are not prepared to manage the influx of data that will be necessary to adequately calculate their reserves under the FASB’s CECL model, it is perhaps more surprising that 37 percent of those surveyed are not familiar with the model itself. Over one-third indicated they had little to no familiarity with FASB’s CECL model, consequently confirming a lack of preparation and understanding of how the plan would impact their current method of determining the reserve.
In late July, the International Accounting Standards Board (IASB) instituted reform to its previous incurred loss model. European banks and other banks outside the U.S. will have to record expected losses for all loans in the first twelve months, and will have to account for losses over the life of the loan if a credit impairment is probable. The release of the CECL model was previously met with skepticism by some U.S. banks, but the passing of the IASB’s IFRS 9 Financial Instruments leaves the reality of the CECL model nearly indisputable.
Among respondents familiar with the expected accounting standards changes, more than one-third – 34 percent -- noted that their institutions would wait until the CECL model is finalized before implementing an automated solution. Only 12 percent already have software compliant with the new model’s proposed requirements.
Ed Bayer, managing director, financial institutions division at Sageworks, commented, "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. 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."
About the Survey
SourceMedia Research conducted the online survey on behalf of Sageworks during the months of June and July 2014, collecting responses from 236 banking and credit union executives with a role in credit risk management. The poll’s respondents were all involved in calculating the ALLL reserve or were decision makers for credit risk management software. The sample was drawn from American Banker subscribers.
About Sageworks
Sageworks is a financial information company and the leader in the analysis of privately held companies. The company provides risk-management solutions to financial institutions and financial analysis and benchmarking applications to accounting firms and private companies. Sageworks’ data and applications are used by thousands of accounting firms and financial institutions across North America and internationally.