Four federal banking regulators rolled out a formal definition of a new accounting method and explained how they will supervise its implementation.
The proposed guidance spells out how they will oversee and enforce the current expected credit loss accounting method as it takes effect for many institutions in 2020. Regulators will broadly add CECL to their existing examinations at banks.
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CECL aims to speed up the recognition of losses, requiring financial institutions to set aside reserves at origination for lifetime expected losses on loans.
The Office of the Comptroller of the Currency, Federal Deposit Insurance Corp., Federal Reserve and National Credit Union Administration jointly issued the proposed guidance on Aug. 19 during an FDIC board meeting.
The agencies will fold CECL into their regular banking examination processes, according to the guidance, and may check for a slew of items to ensure firms' compliance with the standard.
"Examiners may consider the significant factors that affect collectibility, including the value of collateral securing financial assets and any other repayment sources," the proposed guidance states. "Supervisory activities may include evaluating management’s effectiveness in assessing credit risk for debt securities (both prior to purchase and on an ongoing basis)."
Additionally, examiners may review an institution's methods for calculating its allowance for credit losses, including the documents supporting the "reasonableness of management’s assumptions, valuations, and judgments." Examiners may also assess if a firm's board or management oversight is effective at identifying, measuring, monitoring and controlling credit risk.
The guidance also includes a section for examiners, signaling to institutions what examiners' approach will be when reviewing CECL compliance.
The agencies wrote that examiners should recognize that an institution's processes for calculating allowances for credit losses require "the exercise of a substantial degree of management judgment." Furthermore, the guidance cautions examiners that even when an institution estimates with due diligence in its processes, expected credit loss "is not a single precise amount," and estimates may result in a "range of acceptable outcomes."
The guidance states that an examiner should generally accept an institution's estimates and not seek adjustments when the firm has given adequate support for the process it used.
"It is inappropriate for examiners to seek adjustments to [allowances for credit losses] for the sole purpose of achieving ACL levels that correspond to a peer group median, a target ratio or a benchmark amount when management has used an appropriate expected credit loss framework to estimate expected credit losses," the proposed guidance states.
If an examiner finds that an institution's estimates are not appropriate or determines that the processes are "deficient," it will be noted in the exam and communicated to the board of directors and senior management. In addition, the guidance states that "additional supervisory action may be taken" by the regulator.
The guidance is in the proposed stage and is subject to a 60-day comment period. The guidelines come amid dwindling efforts on Capitol Hill to delay or kill the new standard.

