Potential Impact of CECL: Consistency in Loss Reserving and Risk Management
Anticipated changes resulting from the new current expected credit loss (CECL) standard are a topic of wide conversation. In this post, we discuss the impact on consistency in loss reserving and risk management across bank and nonbank lenders.
- Will CECL level the playing field across lenders?
- Will nonbanks be impacted more than regulated banks?
Non-banks Lose an Edge?
CECL could potentially impact the financial system by leveling the playing field between bank and non-bank lenders.
As indicated in the chart below, the portfolios of lending institutions that are not directly regulated by agencies overseeing banks or credit unions have grown significantly in the wake of the recession raising concerns around systemic risk. During the last recession, regulators were able to intervene quickly and provide support given that most of the credit was provided by regulated financial institutions. With non-banks expanding into the mortgage origination market and fintechs and other non-bank lenders providing an increasing number of consumer loans, a large share of household credit is now outside of regulators’ reach. The chances of system-wide failure during a crisis are higher as a result.
Sources: Federal Reserve, Moody’s Analytics
The financial crisis resulted in an increase in the capital requirements facing regulated banks and credit unions. The Dodd-Frank Act stress testing program and the Federal Reserve’s annual Comprehensive Capital Analysis Review (CCAR) process forced the largest banks and credit unions in the country to run detailed analyses of their credit loss positions and gave the Federal Reserve the power to withhold dividend payments to bank shareholders. While institutions decried the increased regulatory burden, these exercises were instrumental in restoring confidence in the banking system. US banks now command a premium position in the world and are enjoying record profits – partly due to the increased strength of their balance sheets.
At the same time, these regulatory burdens created an opportunity for non-bank institutions to expand into markets, such as personal loans and mortgages.
While benefitting consumers, these non-bank lenders may have introduced additional risk into the system. With fewer publicly available financial disclosures and limited regulatory oversight, it is difficult to judge the size and scope of non-bank lending overall.
As CECL will apply to all types of institutions, it should allow for greater comparability of loss estimates across the lending industry. Forcing all lending institutions to set aside loss reserves at origination should lead to more prudent – and more consistent – risk management across both banks and nonbanks. To the extent CECL reveals any underpricing or overly optimistic assessments of credit quality among particular lenders, it could lead to higher interest rates for certain products and a reduction in available credit. While contractionary in the short term, a more level playing field would reduce the amount of risk in the financial system as a whole.
While different from IFRS9 in some key respects, CECL should make international comparisons easier as loss reserve standards can vary by geographic jurisdiction. Greater transparency across the globe should result in a more efficient allocation of capital and reduce some of the risk of another international financial crisis.
CECL’s disclosure requirements will shed more light on the lending standards and portfolios of non-bank lenders. More direct comparisons will allow investors to better assess risks and impose consistency across lenders.
To view additional potential impacts of CECL on consumer lending and the broader economy, read the full blog, “Potential impact of CECL.”
For more information on how we can help your financial institution prepare for CECL, call your Equifax account representative, or contact us today. Additional resources can also be found on Equifax and Moody’s Analytics websites.
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