Some banks and their lobbyists have enlisted the help of Members of Congress, seeking to defer implementation of the Financial Accounting Standard Board’s or FASB’s Financial Instruments–Credit Losses standard, commonly known as CECL. Even more disconcerting, a bill was recently introduced that would for all practical purposes put an end to independent, private sector accounting standard setting.
Following the financial crisis, banks, investors, and policymakers all generally agreed that we needed a better, more timely way for banks to report potential loan losses. As the financial crisis demonstrated, waiting until a loan is in default to report a credit loss is too late, especially when the bank knows that its loans will not be repaid long before the actual default.
CECL, while it may be imperfect, is an improvement to the timeliness of bank’s reporting of credit losses to investors. Even the critics of CECL must acknowledge that, at a minimum, it provides more disclosures intended to help investors better understand and evaluate a bank’s changing credit risks and related management estimates.
Legislation introduced in the House and Senate would delay CECL’s implementation while someone conducts a study of CECL’s economic impact. Well, somebody already has. The Federal Reserve recently released a study entitled CECL and the Credit Cycle, which has a very straightforward conclusion: CECL is much more likely to be countercyclical than procyclical. In other words, if CECL had been in place during the financial crisis, it would likely have slowed the increased lending in the run up to the crash, and accelerated lending following the crash.
In another line of attack on CECL, recently introduced H.R. 4565, the Responsible Accounting Standards Act of 2019, seeks to impose standards designed for federal regulatory agencies on the private sector FASB. The legislation seems to ignore FASB’s already rigorous and transparent standard-setting processes that are far more independent than the regulatory structure the bill seeks to impose.
It should be noted that FASB adopted CECL after an eight-year process that included three documents put out for public comment; meetings with hundreds of individuals and organizations, including banks and bank regulators; public roundtables; and the careful consideration of more than 3,300 unique comment letters. Now, as the January 2020 effective date for some banks approaches, FASB remains committed to listening to stakeholders and assisting them with CECL implementation. This is evidence that the private sector standard-setting process works.
Unfortunately, CECL’s critics have created confusion in the current public debate regarding the standard’s effects. Some banks and their lobbyists argue that the CECL standard creates burdensome bank capital requirements, which, in turn, will affect a bank’s ability to lend money in support of economic activity during a sudden economic downturn. The Fed study referenced above refutes this contention. What is often missing in this debate is the critical distinction between accounting standards used for public reporting purposes that are intended to serve the information needs of investors, and the application of such standards for prudential supervisory purposes.
It is quite appropriate for bank regulatory authorities to assess if accounting standards used for public financial reporting purposes should be automatically applied for prudential regulatory purposes. Such authority resides today with prudential supervisors of financial institutions and is being exercised in response to the CECL standard. For example, last December, the Federal Reserve, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation issued a final rule revising regulatory capital rules in anticipation of the implementation of the CECL standard, providing an option for banks to phase in the impact of the standard on bank capital requirements. More recently, bank regulators issued a proposed policy statement to “promote consistency in the interpretation and application of the standard.”
Members of Congress should strive to protect the investor-oriented public reporting purpose underlying the development of accounting standards and avoid actions that confuse the role of independent accounting standard setters with the role of prudential supervisors of financial institutions. Any consideration by Congress regarding the effect of accounting standards on financial institutions and bank lending should be directed to prudential regulatory authorities, as appropriate.
The Council of Institutional Investors, like most investors, companies, and other capital market participants, strongly supports the existing independent, private sector accounting standard-setting process—one that is subject to public scrutiny and shielded from undue influence, including from banks and their lobbyists. Public due process procedures, appropriate oversight, technical expertise, and, most of all, independence are critical to ensuring the legitimacy of the accounting standards-setting process, and to protect the goals of transparency, relevance, and usefulness of financial reporting that are critical to the success of the U.S. capital markets.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Jeffrey P. Mahoney is the General Counsel of the Council of Institutional Investors, a nonprofit, nonpartisan association of public, corporate and union employee benefit funds, other employee benefit plans, state and local entities, and foundations and endowments. Prior to joining CII in 2006, Mahoney was counsel to the chairman of the Financial Accounting Standards Board.