To suggest that the past several years have given rise to some significant changes in accounting is to understate the case to a great degree.
In this video, Reza Van Roosmalen, accounting advisory financial services industry leader, provides depth on several of the most noteworthy accounting rules to have impacted banks in quite a while. They include changes impacting revenue recognition, lease accounting, hedge accounting, and loan-loss calculation.
All changes will have (post 1/1/2020) impact on capital of the banks that is freely distributable to shareholders.
Van Roosmalen discusses what bank executives are doing to ensure compliance, including forming cross-functional steering committees as well as engaging specialists in risk and the finance. What’s more, data integrity is even more essential as compliance complexity increases.
We've just had a period of tremendous accounting change. And now the big one is upon us for effective 1/1/2020, which is the current expected credit loss standard, the CECL standard for recognition of credit losses on loans.
The impact is to the accounting books and records of of the banks. This will all directly impact also the capital of the banks that is freely distributable to the shareholders. You know, regulators are always very interested in the level of the capital of the banks to make sure that the banks are able to function prudently in the environment. There may be some diverse impacts. But essentially the issue is that we are going to have an accounting rule that is forward-looking, looking at what the expected credit losses are on a loan that that a bank issues. Whereas today you have to wait until the actual loss event occurs and then you book a loss.
The unique thing about the new CECL standard I think is that for the first time we're seeing a US gap standard that's fairly broad and open and principles-based, which means there's a lot of decision making that needs to take place. The banks have to make their own decisions. Whereas I think in the past they've been used to getting very prescriptive guidance and just implementing that. That means in this case that the bank has to come together and organize the steering committees that are very cross functional, people in the risk organization, people in the IT organization and the finance organization.
There's going to be different views. There's going to be different levers to pull as it relates to these decisions. So, one of the big challenges in the CECL standard has been the lack of speed frankly that the banks have been able to make these decisions and then subsequently start implementing those decisions. So that's one big standard.
The other one is data. Data is always going to be an issue. There's a lot of old systems in a lot of banks and through history of M & A and acquisitions may be incomplete data sets. Those data sets now you need to use the data to run the models to calculate the expected credit losses. So, there's going to be data issues, cleaning up data, incompleteness of data sets, data lineage, the controls. The governance over the data is another big challenge. And I think another one is the enhanced disclosures around the vintage of origination of loans that is being required by the new CECL standard.
I think it's not a secret that the audit of the allowances is already one of the trickier areas today, and it's not going to change under CECL. This is going to be the most important estimate on the book of a bank. It's going to have the most amount of judgment in there. All of these things are very hard to audit. What's going to be really important, and it's going to come down to as always, making sure that there's sufficient documentation of the basis of the decisions for the model, how the model is going to be executed, but also being able to follow the data all the way from the origination to the journal entry. So, those are some of the major audit challenges under CECL.