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Pandemic Plus Loan-Accounting Change Equals Huge Bank Problems

March 20, 2020, 4:44 PM

Long before the coronavirus pandemic upended the economy, bankers warned that sweeping new accounting rules forcing them to book losses before they happened would create chaos in an economic downturn and dry up lending when customers needed money the most.

Their warnings seemed dire and perhaps hyperbolic. Then came Covid-19. As the virus spreads, so too do the calls to delay the current expected credit losses (commonly called CECL) standard, alter it, or make bank regulators intervene.

“This is everything everyone was worried about,” said Michael Fadil, chief risk officer at Home Diversification Corp.and former vice president at Citizens Financial Group Inc. “If this doesn’t open people’s eyes and cause enough problems for people to get worried, then I don’t see what could dismantle it.”

Published in 2016 as the Financial Accounting Standards Board’s signature response to the 2008 financial crisis, the new accounting rules require businesses to book the losses they expect rather than waiting for them to happen. The rules apply to all businesses and can impact many processes, but will hit banks and the way they report their loans the hardest. It is meant to reverse much-criticized accounting that made bank balance sheets look rosy in the lead-up to the 2008 crisis.

The rules don’t change the economics of a loan or the underlying strength of a financial institution, FASB says. The new standard instead is supposed to better reflect the economics of lending. If a bank offers home mortgages in a town where a major employer is in financial trouble, for example, the bank could take potential unemployment into consideration when estimating which customers could miss payments. Then the bank would set aside reserves to cover those losses. The standard also offers flexibility. Banks look as far into the future as is “reasonable and supportable,” not years or decades if that’s not possible.

But that’s cold comfort to banks during trying economic times. When they expect losses, as they do right now, they must book them. And as businesses close, gig workers lose paychecks, and travel grinds to a halt, they expect those losses to pile up. At this point, they just don’t know by how much.

Banks have another worry. Unlike other businesses that must follow the new accounting, they also have to comply with bank regulatory requirements. The reserves a bank sets aside for accounting purposes affects the capital they must hold. Banks can’t touch that capital.

“Accounting rules get weaponized by regulatory capital rules,” said Ethan Heisler, senior director at Kroll Bond Rating Agency Inc. “There’s nothing wrong with accounting rules like CECL if you didn’t have capital implications.”

Day Two ‘Hell’

Bank regulators in December 2018 finalized a rule that allows the so-called day-one capital impact of moving from the old accounting rules to CECL to get phased in over three years. The move from the Federal Deposit Insurance Corp., Federal Reserve, and the Office of the Comptroller of the Currency eases the initial hit of shoring up capital on the first day the new rules take effect. That was Jan. 1 2020 for large, publicly traded banks and will be 2023 for credit unions, privately held banks, and smaller public companies.

But that capital phase in doesn’t ease the blow to capital as banks increase expected losses on an ongoing basis, only day one. No one knew coronavirus would wreak havoc come March. The fallout from the virus is considered “day two,” Heisler said.

“Day one was blue sky,” Heisler said. “Day two is hell on earth.”

The American Bankers Association raised this issue in July 2018 when the bank regulators proposed the phase in. The group warned that a day-one phase in would be “futile” and “of little benefit” in a deteriorating economic environment. The group called for further capital relief measures.

Few people expected the economy would be in such a different place less than two years later.

Capital Impact on Lending Decisions

If banks have to increase the capital they hold because of increased expected losses, it could affect how and when they extend credit. Riskier loans to customers on the lower end of the credit quality spectrum may be more “expensive” from a capital perspective, said Reza van Roosmalen, accounting change services lead at KPMG LLP.

“There may be some lending decisions that will change based on that,” van Roosmalen said.

This is what banks say they don’t want to happen. Would-be borrowers look increasingly risky during economic turmoil and if an accounting standard makes them book bigger losses and set aside more capital, they could make fewer loans. More than 80 mid-sized and regional banks raised this issue in letters to Congress on Thursday, calling on lawmakers to intervene and force a pause on CECL implementation.

“CECL requires our banks to set aside capital for potential losses over the entire life of the loan—taking needed capital out of the system during a moment when it is most needed,” wrote banks including U.S. Bancorp, American Express Co., and Truist Financial Corp.

Reversing course on CECL for banks that have already implemented it may not make sense, however, financial reporting experts told Bloomberg Tax. The accounting overhaul was a major endeavor for most financial institutions and many had to buy new software and install new accounting systems to comply with the change. They simply don’t have access to the accounting tools they used before 2020, they said.

The regional and mid-sized banks hinted at that in the letter to lawmakers, saying large “money center” banks could choose to stick with CECL. For other banks, they could choose whether to start following the new rules this quarter or not.

But there’s a growing chorus of financial reporting professionals who believe the solution is in the hands of bank regulators. Easing the capital impact of CECL would blunt the biggest downside of the accounting change.

“Everyone is just crying out for this to happen because if they don’t get the relief, then come earnings, it could look somewhat dire,” said Ben Elliott, Washington policy analyst for Bloomberg Intelligence.

The Federal Reserve and the OCC did not respond to emails seeking comment. FDIC Chairman Jelena McWilliams on Thursday took the unusual step of writing to the FASB and calling on the standard-setter to allow banks to hold off on implementing the rule change amid “unprecedented” economic change.

The regulators have said several times over the past year that they would not intervene in the accounting standard-setting process, which is established by FASB, but they would closely monitor any questions or problems banks have as they overhaul their accounting.

“They’re looking at it and they’re very aware,” said Sydney Garmong, managing partner at Crowe USA LLP. “They are not deaf as to what’s going on.”

To contact the reporter on this story: Nicola M. White in Washington at

To contact the editors responsible for this story: Jeff Harrington at; Joe Stanley-Smith at

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