Collaborating Author: Tim Biddle
If you are a financial institution, then you probably have spent time learning more about CECL and the challenges it will have on your data capabilities. You may be asking yourself, “Why is data and data management so much more important to CECL compliance than it has been under the incurred loss model?“
CECL represents a fundamental and deceptively complex change to establishing reserves. If your company built a CECL model, then you probably realized that the CECL data requirements became very extensive and detailed – it could be more or less depending on your company’s complexity and the reserve methodology chosen. Given CECL’s complexity, FASB has given you approximately three years to prepare for and comply with CECL (SEC filers have until 12/15/2019 while non-SEC filers and non-profits have until 12/15/2020).
In these next three years, make sure you can answer the following questions:
- Do you know the potential differences in reserve amounts across methodologies for any given portfolio? Take the time to fully understand CECL, the potential impact of different reserve methodologies and the data needs associated with these methodologies, which are discretionary and are likely to vary by loan portfolio. More data will allow you to optimize your chosen reserve methodology for any particular portfolio.
- Can you reliably document the sources of data used in your reserve calculations? Are the sources consistent between portfolios and periods? Make sure you bridge any gaps in your data or data practices to obtain and manage the information needed to support your chosen methodology.
- Are you confident that your reserve trends reasonably capture portfolio performance and forecasted economic trends? Are they generally in line with industry trends? Will your methodologies pass an audit and regulatory scrutiny? Do you have processes in place to ensure all of the above? Ensure your chosen reserve methodologies produce logical, supportable and consistent results based on sound data governance, data management, data quality, data analytics capabilities and data security.
A key component of your CECL exercise should be a cost/benefit analysis regarding how sophisticated your company wants to be with regard to CECL compliance. Does the cost of supporting more sophisticated reserve calculations (i.e., more data and a more robust data culture) outweigh the benefit of supporting potentially lower reserves?
More and better data usually results in “better” compliance (i.e., reserve levels that are logical, put less pressure on capital, are more accurate and representative of reality and can withstand both regulatory scrutiny and an audit). However, there are costs associated with supporting more data and a more robust data culture. Volumes of high quality data and a top shelf institutional data culture are not necessarily required to comply with CECL, however using less data may result in higher reserves and may invite more regulatory and auditor challenges. The trick is finding the right balance for your organization that will optimize compliance with CECL at the lowest overall cost.