As banks prepare to implement the Current Expected Credit Loss standard, the American Bankers Association on Friday called on financial regulators to provide for a complete and ongoing adjustment of common equity tier 1 capital for the effects of CECL until a new capital regime can be finalized. ABA noted that CECL will have a significant effect on the volatility and level of bank capital, and could increase procyclicality in the industry — which the agencies did not take into account in their recent proposal to amortize the initial capital impact of CECL over three years.
“ABA supports the agencies’ efforts to address the effects CECL will have on regulatory capital,” the association wrote in a comment letter to regulators. “However, a transition based on the ‘day 1 difference’ does not recognize that deterioration in economic conditions experienced soon after the effective date could make such a plan ineffective, if not futile. The transition would be of little benefit within a deteriorating environment.” ABA added that “absent other regulatory guidance, the economics of the business will change, access to certain credit products may decline during economic downturns, and banks of all sizes will need to consider vast changes to product mix and pricing.”
In addition to providing for an ongoing adjustment to CET1 capital, ABA urged the agencies to undertake a quantitative impact study that would address the effects of higher and more volatile allowances across the industry throughout various phases of an economic cycle. The association recommended that the study address specific products — noting that longer-termed lending products such as residential mortgages will likely experience dramatic increases to capital volatility — as well as how CECL will specifically affect community banks.
CECL becomes effective in 2020 for SEC registrants and in 2021 for all others. As it requires forecasted lifetime losses across all loans and held to maturity debt securities, U.S. banks will be holding reserves significantly higher than those that follow International Financial Reporting Standards, which requires allowances for loans that have not experienced significant credit deterioration that approximate a twelve month default estimate. In addition to the CET1 capital adjustment, ABA offered further suggestions on leveling the playing field in the long term.