A pair of recent surveys sheds further light on continued uncertainty in the financial services sector over how to project credit losses in compliance with a new accounting rule.
Two-thirds of entities in the financial services sector are still assessing how they’ll be affected by radical changes in how they are required to reflect losses stemming from debt-based financial instruments in financial statements, according to a poll by KPMG. The accounting standard, set forth by the Financial Accounting Standards Board, takes effect in 2020 to require entities to take a more forward-looking approach to those investments when booking losses.
The “current expected credit loss” model developed by the FASB requires entities to use both historical information and projections to estimate how much they believe they will lose as a result of credit-based instruments and book those expected future losses at inception. That day-one recognition under the CECL model is different from the approach embraced by the International Accounting Standards Board, which allows entities to assume full performance of the debt instruments for at least the first year.
The KPMG poll of nearly 100 different entities in the financial services sector suggests 67 percent are still assessing the standard and its effect before moving into implementation of the new requirements. Insurance entities are even more stumped, with nearly 90 percent still in the assessment phase. Half of all respondents said they are not able to estimate what it will cost them to comply with the CECL accounting model.
At a high level, companies in the financial services sector are predicting some broad systemic effects of the new accounting standard. Nearly three-quarters said it will cause income volatility, half said it will affect their compliance with regulatory capital requirements, and more than one-forth expect implications for their asset liability matching and management. Roughly three-quarters also predict an increase in their credit loss allowances of anywhere from 20 percent to 60 percent.
A separate survey by software provider SS&C Technologies says banks initially expected to be able to leverage their existing processes for reserving for credit losses under the new standard, but now are not so sure. In 2016, 85 percent said they were confident they could build off existing processes, but in 2017, only 43 percent believe so.
The firm says financial institutions that want to perform dry runs under the new accounting ahead of the effective date — the intent of more than half in 2016 — are running out of time. “Since functional system requirements must be implemented before parallel processing can begin, banks that find themselves behind the curve could have to cut their practice runs short,” the firm says. The survey data suggests only 8 percent of companies are actively implementing CECL requirements now, the firm says, so progress in 2018 will be critical.
Reza van Roosmalen, KPMG’s U.S. change leader for financial instruments, said financial institutions are facing some ambiguity as a result of the “open-ended nature” of the CECL standard. The principles-based standard gives companies latitude in determining how they will measure their expected losses. "The banks and insurers have a number of options to consider in this standard, and implementing CECL requires companies to put their stake in the ground and build their processes around it,” he said.