A pending new accounting standard on credit losses could undermine the stability of the financial system in a recession and should be delayed so it can be further studied, according to nearly 50 banks that are asking the U.S. Treasury to intervene.
The Financial Accounting Standards Board is studying a request from Greg Baer, CEO of Bank of America and chairman of the newly formed “Bank Policy Institute,” addressed to Treasury Secretary Steven Mnuchin asking for a review by the Financial Stability Oversight Council of the systemic and economic risks posed by implementing the accounting standard. The “current expected credit loss” approach to recognizing loan losses in financial statements required under the new standard will threaten stability in a future recession or financial crisis, Baer says, because it will give banks a disincentive to extend credit during stressed economic conditions.
Public companies are required to adopt the CECL approach by Jan. 1, 2020. FASB adopted the new approach in 2016 to do away with prior rules that required companies, most notably banks and other types of financial institutions, to delay recognition of losses until they were almost certain to occur.
The idea behind the new, more forward-looking approach, which the board developed during the recession following the 2008 financial crisis, is to give investors more early warning about losses. The board issued the rule in Accounting Standards Update No. 2016-13, now contained in Accounting Standards Codification Topic 326.
As financial institutions have worked to prepare for the new accounting, they are contemplating the effects it will have on capital requirements and lending practices. Baer, writing on behalf of the nearly 50 banks that have joined the BPI in its recent formation, says the CECL approach to recognizing loan losses is “likely to adversely affect the availability, structure, and price of credit at all times, with a disproportionate impact on longer-term and higher-risk loans, including residential mortgage, small business, student, and unsecured term and non-prime lending.”
BPI’s letter to Mnuchin asks the FSOC to evaluate the systemic and economic risks and “engage with the FASB” and other regulatory agencies to seek a delay in CECL’s implementation. Banks are particularly concerned that the CECL standard requires banks to recognize possible future losses upfront, even when loans are fully performing, which ultimately magnifies losses, especially during a downturn in market conditions.
A FASB spokesman said FASB Chairman Russ Golden has received his copy of the letter and “will respond in writing [to Baer] in due course.” Since the board issued the standard in 2016, FASB has continued to meet regularly with banking institutions and banking regulators, she said. “We will continue to work with these organizations to ensure a smooth and effective implementation of the standard and stand ready to answer any questions as they arise,” she said.