FASB Refuses to Let Regional Banks Avoid Taking Earlier Loss Reserves
On June 16, 2016, the Financial Accounting Standards Board (“FASB,” the private, non-profit body which sets and revises Generally Accepted Accounting Principles), adopted a new accounting standard applicable to lenders, primarily banks. The new standard, “Current Expected Credit Losses” (CECL), is to take effect at the beginning of 2020. The existing standard, “Allowance for Loan and Lease Losses” (ALLL), requires lenders to establish a reasonable reserve to cover a loss on a loan or finance lease once it is known with reasonable confidence that a loss may occur. The practical result, as evidenced by repeated regulatory pronouncements, is that lenders have tended to delay recognizing the possible existence as well as possible extent of a loss. In the “Great Recession” of 2008 that tendency was revealed to have left lenders catastrophically under-reserved against loss.
As part of a subsequent review, the FASB crafted the new CECL standard, which requires lenders immediately upon making a loan or other extension of credit, to begin taking reserves equal to the estimated losses over the remaining life of the credit extension. Federal bank regulators estimated this would result in reserves that were 30% to 50% greater than under the ALLL standard. In other words, extending credit would be less profitable in terms of the reported financial results of the lenders. A concern expressed particularly by banks is that the CECL standard will make banks less willing to lend to borrowers with higher possible credit risks, thus, slowing commercial activity.
On December 21, 2018, the Federal bank regulatory agencies approved a final rule requiring banks regulated by them (i.e., all except private, non-insured institutions) to phase in the new CECL standard over three years beginning in 2020. That final rule was to become effective April 1, 2019 but was delayed until July 1, 2019 due to the Government shutdown at year end. A number of Regional Banks (generally, those between $50 billion and $500 billion in assets) petitioned the FASB to modify the provisions of the CECL standard to allow for more modest reserve levels until events occurred which heightened the possibility of a credit loss and, hence, required a lending bank to take additional reserves with respect to that financing. On Wednesday, April 3, 2019, the FASB rejected their petition.
Under the July 1, 2019 final rule, regulated banks may voluntarily elect to begin complying with the CECL standard in the first quarter of 2019. Many commentators suggest that the CECL standard will be less troubling for community banks, which tend to maintain stronger credit quality by taking more constrained risks than their larger rivals. Compliance with the CECL standard requires careful evaluation of credits not only at inception but also on an ongoing basis.