Agricultural Economics Department
Date of this Version
5-25-2022
Document Type
Article
Citation
Cornhusker Economics May 25, 2022
Abstract
Current Expected Credit Losses (CECL) is a new expected credit loss accounting standard that was first introduced by the Financial Accounting Standards Board (FASB) in 2016. This new method is meant to replace the current Allowance for Loan and Lease Losses (ALLL) standard. CECL requires the estimation of expected losses over the life of a loan, while ALLL is based on historic, or incurred, losses. This change largely affects banks, but other financial institutions that hold or trade securities can also be subject to the rule. Although CECL was introduced in 2016, the implementation of the rule has had a slow rollout and faced further delays due to economic policy in response to COVID-19. Many larger banks have already adopted CECL, and as of January 2023, all insured depository institutions will be required to maintain the CECL standard. Moving from incurred losses (ALLL) to lifetime losses (CECL) can be a challenge for many banks. To estimate expected future losses, banks need to forecast economic changes and the impacts on their portfolios. Many banks may face limitations in their ability to generate proper forecasts or to capture the quality of data needed to make such estimates. These challenges can be the greatest for smaller community banks which may lack the appropriate resources to develop this type of approach. In response to the difficulties associated with CECL implementation, the Federal Reserve issued the Scaled CECL Allowance for Losses Estimator (SCALE) in July of 2021. Meant for institutions under $1B in assets, SCALE is based on the utilization of loss rates from larger banks that follow CECL requirements. Rather than deriving their own expected loss rate, banks using SCALE can calculate an average lifetime loss rate, coming from a group of larger peers, as a proxy for their own. If SCALE can provide appropriate estimates, it can be a suitable alternative to the development of a full CECL model, saving community banks time and resources.
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