Credit loss accounting: To centralize or decentralize?

Answering the big questions for CECL and IFRS 9 dual reporters

U.S.-based global banks face a conundrum. The United States Financial Accounting Standards Board (FASB) has finalized a new accounting standard governing how the allowance for credit losses is recognized and measured. So, too, has the International Accounting Standards Board (IASB), the major international accounting rule-making body. And they are not exactly the same.

Both rules—the Current Expected Credit Loss (CECL) standard from the FASB and International Financial Reporting Standard 9 (IFRS 9) from the IASB—change financial instrument accounting by shifting the paradigm of the calculation of credit loss. Both mandate institutions replace incurred loss models with forward-looking expected loss models. And there is a lot of intersection between the requirements of the two models.

But there are also substantial differences in the details. Namely, there are different requirements for what the models need to estimate. While it will be possible for dual reporters to use the same type of model, they will need to enhance it to be able to do both accounting standards.

At first glance, centralizing adoption of both standards with a collective solution seems to make sense. After all, for some entities, preparing for the switchover to both standards may be a big deal for groups responsible for preparing and approving the entities’ financial statements. Implementation and compliance with IFRS 9 and CECL may be time consuming, cost intensive, and complex, as meeting the requirements of the accounting standards will likely require an overhaul of many aspects of accounting systems and processes. From business continuity and financial and practical perspectives, many institutions may want to kill two birds with one stone.

But is shortcutting the exercise with an all-in-one solution prudent, or will it burn banks in the long run? Will a fully centralized approach cause any problems or raise any red flags?

One concern is that banks may feel trapped into first dealing with IFRS 9—which for most reporters is effective starting in January 2018, a full two years before CECL—despite their desire to focus on the larger issue of CECL that applies to all of the domestic and international financial instruments within the scope of the standards. In other words, the shorter-term need to focus on IFRS 9 may not fit into larger CECL efforts.

Another is that a common infrastructure may not enable banks—especially global systemically important financial institutions (G-SIFIs)—to meet the high standards for IFRS 9 by each country’s specific financial regulator. For example, credit loss models they develop to use across the board may not be sensitive or customized enough to handle the compliance and reporting requirements for IFRS 9 and CECL for asset classes specific to different countries.

This is a concern even in localities where U.S.-based global banks have limited foreign balance sheet exposure. No matter how materially small a bank’s portfolio in a certain country, local financial regulators will expect them to be sophisticated in their calculations—and they are being closely watched. Considering local filings as “just a nuisance” could cause major problems.

Some institutions worry that using a global solution that tries to be one-size-fits-all for IFRS 9 and CECL compliance for both the standards might make their subsidiaries subject to more stringent rule interpretations and compliance oversight than individual country regulators might otherwise require. Regulatory scrutiny over the accounting of IFRS 9 and CECL may be the same for any portfolios that share a platform, meaning leveraging a global solution built for material-based portfolios may increase scrutiny on less material portfolios in foreign countries.

Another issue—and one that may be a wake-up call to some accounting leaders—is that IFRS 9 requirements, on a whole, are more prescriptive than CECL requirements. While some foreign banks may find success leveraging their IFRS 9 infrastructure for CECL, it may be harder for U.S. banks in the opposite scenario, having started with a CECL implementation. U.S.-based global banks will need to make major changes and enhancements to enable CECL infrastructure to address certain IFRS 9 requirements that are optional or not required under CECL. And then there is the Catch-22: That banks may develop a CECL-focused solution with so many exceptions and special capabilities for IFRS 9 that it becomes overly complex and costly for run-of-the-mill reporting in the United States.

All of these factors are moving some U.S.-based dual reporters to decentralize adoption—developing a stand-alone CECL solution for the core U.S. business, but pushing IFRS 9 model development to local subsidiaries on foreign soil. But this method also presents risks.

The main one is the sheer burden. A decentralized approach could overly complicate the project, possibly causing duplicate work and substantially driving up costs. Some dual reporters are considering almost 2,000 different enterprise-wide macroeconomic variables in their credit loss models, with overlays and adjustments based on local, regional, or country variables—an immense undertaking for the accounting, finance, and risk teams that will likely require a costly overhaul of technology systems and data processes.

Decentralization also presents a resource question. Will subsidiaries in foreign jurisdictions have the expertise and resources to manage IFRS 9 compliance processes, especially subsidiaries that are relatively small and insulated from the core business?

So how sophisticated or simplistic should U.S.-based global banks be when implementing CECL and IFRS 9 credit loss modeling and accounting? In the end, what is the right method? Is there even a right answer to that question?

Having been at the forefront of many CECL and IFRS 9 implementations, KPMG LLP (KPMG) understands the pitfalls of taking an all-or-nothing view—centralizing or decentralizing all credit loss accounting. Our view is that U.S.-based dual reporters should take a hybrid approach: For the many synergies and common components between CECL and IFRS 9 solutions, banks should centralize the majority of the work of adopting both standards to create efficiency. But at the same time, they should customize IFRS 9 implementation on a local level to reduce the number of potential traps with local regulators.