Key Insights
- No matter the future of CECL, community financial institutions should stay exam-ready.
- Overly complex CECL frameworks cost more. Right-sizing reduces operational and audit burdens.
- Simpler methods, peer benchmarking, and third-party vendors can streamline CECL compliance effectively.
In the 1981 film The Incredible Shrinking Woman, Lily Tomlin plays a housewife and mom who starts to shrink after she is exposed to an experimental perfume made by her husband’s company. Tomlin’s character shrinks so much that she must move into a dollhouse before eventually shrinking so much that she is no longer visible, leaving people to assume that she has died and completely disappeared. But while microscopic, she falls into a puddle of household chemicals which miraculously returns her to her original size.
Fortunately for the banking industry, it doesn’t require complicated chemical compounds or a cinematic miracle to right-size Current Expected Credit Losses (CECL) frameworks. What it does require is caution and an intentional approach. This means that community financial institutions (CFIs) should consider adjusting their CECL model regularly as economic conditions, loan mix, and credit-risk indicators change rather than treating a one-time CECL adjustment as their permanent solution.
Fortunately for the banking industry, it doesn’t require complicated chemical compounds or a cinematic miracle to right-size Current Expected Credit Losses (CECL) frameworks. What it does require is caution and an intentional approach. This means that community financial institutions (CFIs) should consider adjusting their CECL model regularly as economic conditions, loan mix, and credit-risk indicators change rather than treating a one-time CECL adjustment as their permanent solution.
CECL Relief Efforts
Federal Reserve Vice Chair for Supervision Michelle Bowman has called on the Financial Accounting Standards Board (FASB) to consider significant CECL relief for community banks, including repeal, an exemption, or a practical expedient. In May, Bowman said the framework had “clearly not improved safety and soundness” for smaller institutions and cited its operational complexity, recurring cost, and limited value relative to those burdens. Bowman's comments represent the position of an individual federal banking regulator, rather than a joint position of the federal banking agencies.
Banking trade groups have raised similar concerns. In an April letter to FASB, the American Bankers Association (ABA) said community-bank CECL costs can outweigh the benefits, particularly because of model-validation, audit and qualitative-adjustment documentation demands. The ABA urged FASB, banking supervisors, auditors and community bankers to work toward more proportionate internal-control expectations and more efficient credit-loss estimates.
FASB is currently conducting a post-implementation review of the standard to address ongoing complaints from smaller institutions regarding its complexity, which is expected to be completed by the end of 2026.
Banking trade groups have raised similar concerns. In an April letter to FASB, the American Bankers Association (ABA) said community-bank CECL costs can outweigh the benefits, particularly because of model-validation, audit and qualitative-adjustment documentation demands. The ABA urged FASB, banking supervisors, auditors and community bankers to work toward more proportionate internal-control expectations and more efficient credit-loss estimates.
FASB is currently conducting a post-implementation review of the standard to address ongoing complaints from smaller institutions regarding its complexity, which is expected to be completed by the end of 2026.
Why Now is a Good Time to Right-Size
With most CFIs having completed their initial transition relief cycles, now is a good time for organizations to review their compliance plans and see where things can be streamlined and improved. Since most organizations’ models were hurriedly thrown together to meet the implementation compliance deadline, there are many cases where CFIs are using overly complicated processes that can create unintended operational and compliance risks. Streamlining processes can help eliminate problem areas and reduce the cost of continuous maintenance.
For most CFIs, the biggest financial burden of CECL isn't the loss model itself, but the administrative burden of documentation, validation, and audit defensibility requirements that were designed for bulge bracket banks that do not match their own operations. Based on feedback provided to the ABA, one of the greatest costs of CECL compliance for CFIs is Q-factor adjustments and qualitative overlays. Community bank examples from ABA roundtables include a 14,000-word, 28-page update to a Q-factor framework and a 125-question CECL-specific audit checklist — though these are not universal regulatory requirements. Additionally, CECL has increased the complexity of the process without altering allowance coverage levels for CFI portfolios, such as residential mortgages and commercial real estate.
For most CFIs, the biggest financial burden of CECL isn't the loss model itself, but the administrative burden of documentation, validation, and audit defensibility requirements that were designed for bulge bracket banks that do not match their own operations. Based on feedback provided to the ABA, one of the greatest costs of CECL compliance for CFIs is Q-factor adjustments and qualitative overlays. Community bank examples from ABA roundtables include a 14,000-word, 28-page update to a Q-factor framework and a 125-question CECL-specific audit checklist — though these are not universal regulatory requirements. Additionally, CECL has increased the complexity of the process without altering allowance coverage levels for CFI portfolios, such as residential mortgages and commercial real estate.
Right-Sizing the Right Way
Unfortunately, right-sizing your CECL framework doesn’t mean doing less. Reassessing CECL the right way means being more intentional. With regulators arguing that banks’ CECL methodologies should match their size, complexity, and risk profile, below are some of the things that CFIs could consider focusing their right-sizing initiatives on:
- Adopt simpler methodologies that are more transparent, such as the Weighted Average Remaining Maturity (WARM) method, which can significantly reduce mathematical overhead.
- CFIs can benchmark against peers instead of trying to model against the standards of bulge bracket banks.
- Streamline documentation by shifting the focus to changes in your risk profile instead of justifying basic model assumptions each quarter.
- Leverage vendor solutions and external data, which can reduce costs and analysts’ workloads. According to the findings of a recent ABA survey, 57% of CFIs rely on economic forecasts from third party-providers and 70% use third-party vendors to assist with the CECL estimation process.
It is important for CFIs to remember that right-sizing does not mean reducing documentation in advance of an exam, as doing so could be a red flag for examiners who may suspect an organization is trying to cut corners. Any process changes should be documented and supported by thorough risk assessments.
Right-sizing CECL frameworks is a good way for CFIs to reduce routine operational costs and audit costs, and can help organizations get a jump on anticipated regulatory streamlining. A right-sized CECL framework is a good way to keep regulators and examiners happy, yet to create flexibility for the future.
