	Introduction

Some observers asserted that leading up to the financial crisis of 2007-2009 banks did not have sufficient credit loss reserves or capital to absorb the losses and as a consequence supported additional government intervention to stabilize the financ ial system. In its legislative capacity, Congress has devoted attention to strengthening the financial system in an effort to prevent another financial crisis by passing legislation. In its oversight capacity, while maintaining oversight of reforms implemented through the regulatory agencies, Congress has delegated authority to the bank regulators and the Financial Accounting Standards Board (FASB) to determine minimum credit loss reserves and the current expected credit loss (CECL) implementation. Credit loss reserves help mitigate the overstatement of income on loans and other assets by adjusting for potential future losses on related loans and other assets. Credit losses are often very low shortly after origination; subsequently, they rise in the early years of a loan, and then taper to a lower rate of credit loss until maturity. Consequently, a firm's financial statements might not accurately reflect the potential credit losses at loan inception. U.S. Generally Accepted Accounting Principles (GAAP), currently, require an incurred loss methodology to recognize credit losses on financial statements. CECL requires "consideration of a broader range of reasonable and supportable information" to determine the expected credit loss, including expected loss over the life of a loan or financial instrument by considering current and future expected economic conditions. The expected losses over the life of the financial instrument are to be recognized at the time the financial instrument is created. This report primarily focuses on the effects of CECL on the banking industry, although CECL will also affect other financial institutions and sectors. Current Expected Credit Loss

Credit loss estimates based on CECL are projected to result in greater transparency of expected losses earlier in the life of the loan and improve a user's ability to understand changes to expected credit losses at each reporting period. The proposed changes are significant enough to affect the regulatory capital rules that the federal banking regulators—the Office of the Comptroller of the Currency (OCC), the Federal Reserve, and the Federal Deposit Insurance Corporation (FDIC), collectively, the regulators—have initiated a "notice of proposed rulemaking," to address bank capital requirements. Currently, credit losses in the banking industry are referred to, generally, as Allowance for Loan and Lease Losses (ALLL), or sometimes referred to as allowance for loans. CECL Implementation Dates

Early adopters of CECL may start issuing CECL-based financial statements for financial reporting periods after December 15, 2018. All public companies are required to issue financial statements that incorporate CECL for reporting periods after December 15, 2019. A FASB board member also raised similar concerns stating that the loans in the U.S. commercial banking system increased by 85% in the seven years leading up to the financial crisis whereas the reserves to cover the losses increased by 21%. Since FASB's announcement of CECL, banking industry professionals have raised concerns about implementing CECL, including during congressional testimonies. Others have described the change in how credit losses are determined by adopting CECL "as the biggest bank accounting change in 40 years." As a consequence of CECL's changes, the banking regulators are proposing to replace ALLL with a newly defined term in the capital rules—allowance for credit losses (ACL). Credit loss allowances under CECL cover a broader range of financial assets than ALLL. Banks that use spreadsheets or other internal models to determine credit losses might need to migrate to third-party vendor systems for CECL. Training

In addition to any technology upgrades, there might be additional training costs for stakeholders to implement CECL. According to one estimate, the transition to CECL will likely result in an upfront increase in ACL of between $50 billion and $100 billion. As these projected adjustments are in aggregate across the banking industry, some banks might need to increase their reserves significantly more than the projected 25-50 basis points whereas others might need to adjust less. In 2021, not only will all banking organizations be required to adopt CECL, but also stress tests are to use ACL. Differences in the way that U.S. GAAP and international accounting standards treat credit loss estimates and credit loss reserves could potentially disadvantage U.S. banks. Similar to certain banks being allowed to phase in the increased credit reserves over three years, Congress and FHFA can choose to allow Fannie Mae and Freddie Mac to accumulate the additional reserves over three years, potentially avoiding additional draws from the Treasury.
Some observers asserted that leading up to the financial crisis of 2007-2009 banks did not have sufficient credit loss reserves or capital to absorb the resulting losses and as a consequence supported additional government intervention to stabilize the financial system. In its legislative oversight capacity, Congress has devoted attention to strengthening the financial system in an effort to prevent another financial crisis and avoid putting taxpayers at risk. However, some Members of Congress have expressed concern that financial reforms have been unduly burdensome, reducing the availability and affordability of credit. Congress has delegated authority to the bank regulators and the Financial Accounting Standards Board (FASB) to address credit loss reserves. FASB promulgates the U.S. Generally Accepted Accounting Principles (U.S. GAAP), which provides the framework for financial reporting by banks and other entities.
Credit loss reserves help mitigate the overstatement of income on loans and other assets by accounting for future losses. Credit losses are often very low shortly after loan origination, subsequently rising in the early years of the loan, and then tapering to a lower rate of credit loss until maturity. Consequently, a firm's financial statements might not accurately reflect potential credit losses at loan inception. During the seven years leading up to the 2007-2009 financial crisis, the loan values held by the U.S. commercial banking system increased by 85%, whereas the credit loss reserves increased by only 21%. The ratio of loss reserves prior to the financial crisis was as low as 1.16% in 2006 and was more than 3.70% near the end of the crisis in early 2010.
In response to banks' challenges during and after the crisis, in June 2016, FASB promulgated a new credit loss standard—Current Expected Credit Loss (CECL). The new standard is expected to result in greater transparency of expected losses at an earlier date during the life of a loan. Early recognition of expected losses might not only help investors, but might also create a more stable banking system. CECL requires consideration of a broader range of reasonable and supportable information in determining the expected credit loss, including current and future economic conditions. In addition to loans, CECL also applies to a broad range of other financial products. The expected lifetime losses of loans and certain other financial instruments are to be recognized at the time a loan or financial instrument is recorded. All public companies are required to issue financial statements that incorporate CECL for reporting periods beginning after December 15, 2019. Although adherence to CECL is required for all public companies, it is expected to have a more significant effect on the banking industry. The change to credit loss estimates under CECL is considered by some to be the most significant accounting change in the banking industry in 40 years.
The banking regulators (Federal Reserve, Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency) have issued preliminary guidance on CECL implementation. Banking regulators have also proposed changing the Allowance for Loan and Lease Losses (ALLL) to Allowance for Credit Loss (ACL) as a newly defined term. The change to ACL is to reflect the broader range of financial products that will be subject to credit loss estimates under CECL.
During congressional hearings, banking industry professionals have raised several concerns about CECL. According to one estimate, the transition to CECL will likely result in an increase in loan loss reserves of between $50 billion and $100 billion for banks. As these projections are in aggregate across the banking industry, some banks might need to significantly increase their credit reserves whereas others might need to adjust less.
To mitigate the effect of CECL, regulators have given banks the option of phasing in the increased credit reserves over three years. In addition, the Federal Reserve has delayed stress tests that incorporate CECL for the largest banking organizations until 2021. Banks are expected to incur additional costs of developing new credit loss models and costs of implementation. Banks may need to retain historical information on more financial products to estimate credit losses under CECL. Adopting CECL may require upgrading existing hardware and software or paying higher fees to third-party vendors for such services. Participants in recent congressional hearings have raised concerns about CECL implementation issues. The difference in how credit loss estimates are calculated based on CECL and international accounting standards could potentially disadvantage U.S. banks, but CECL is considered less complex to implement.
Fannie Mae and Freddie Mac, the government-sponsored enterprises, are also to be subject to CECL credit loss estimates as they are subject to private-sector GAAP requirements even though they are currently in conservatorship under the Federal Housing Financing Agency.