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Will CECL Be a Plus or Minus for Your Competitive Position?

Whenever there’s a major change in standards looming, companies subject to it understandably go into heads-down mode, focusing on what they need to do to become compliant. Often, there’s an enormous challenge just getting to the start line—the point where the change is required standard practice.

For help with reaching the starting line for CECL, the new current expected credit loss impairment model in the US, check out FICO’s just-published CECL Hot Topics Q&A. My colleague Lynda Woodward and I answer questions such as:

  • What is the biggest difference in the change from incurred loss to expected loss?
  • What if we don’t have sufficient data to estimate lifetime losses?
  • There’s a lot of talk about increased volatility in allowance estimates under both CECL and IFRS 9. What are the main causes?
  • Are there some hidden implications of CECL for customer experience and relationship building that I should be considering early in the transition?
  • Is there a silver lining to the expense and work of the transition?
It’s important to understand that even though CECL — the US equivalent of IFRS 9 — applies to all US firms with financial assets equally, not everyone will be in an equally strong competitive position at the start line. Some companies will leap forward from the start line as if rocket engines were shooting flames out the back of their running shoes. Other companies may, in comparison, feel like they have lead in their soles.

Your position at start will largely be affected by three things.

1. The questions you ask now.

Don’t be too reassured by surveys that project estimated ranges of allowance impact under CECL. Most projections are based on averages across large, stable portfolios. If yours is a smaller institution and/or you have higher risk portfolios or segments, you need to dig deeper.

Examine the true cost of capital for each slice of your business so you can think clearly about ROI and ROE. Similarly, when it comes to figuring out what data you need for producing lifetime loss estimates, don’t rely too much on general recommendations or industry catalogs. Instead, get specific by doing a gap analysis of your own portfolios. Identify the gaps between what you need to comply and where you are today.

Ask the right questions early, and you’ll spend less time and money getting to the start line—and have more resources available to move ahead from there.

2. How you use increased loss visibility to improve decisions.

The data analysis you do for CECL will increase your visibility into the lifetime risk exposure you’re taking on when you book an account. If you use it to separate portfolio populations into more granular segments, you’ll be able to produce more precise estimates, and thereby avoid tying up capital unnecessarily in frontloaded reserves. That will free funds for initiatives, like improving digital services that improve your competitive position.

At the same time, if you use increased loss visibility to make better risk management and pricing decisions in day-to-day operations, you’ll book and retain more low-risk, profitable customers. Those decisions will reduce capital consumption and generate even more funds for growth initiatives. Thus, top competitors will use increased loss visibility to create tighter links between risk management and finance.

3. Whether or not you act ahead of time to adjust strategies, pricing and practices.

Many institutions currently have only a limited notion of how CECL will impact their business. If you wait until you’re at the start line to figure that out, you risk giving up competitive ground as you spend months just regaining traction.

Now’s the time to think about how you may need to adjust originations policies and pricing, for example, on longer lifetime products and high-risk/high-return segments. In collections, if you offer flexible repayment plans, how might you impact your impairment charge and will these actions have to change? Does CECL shift the point at which it no longer makes financial sense to try to save a customer relationship shift? Can you do more to help customers avoid defaulting in the first place? What’s the added cost of booking riskier populations?

Today, regulatory compliance is more than a requirement and cost of doing business. Smart companies are turning it into yet another opportunity to put daylight between them and the jostling field of competitors. Take steps now to make sure you’re out ahead post-CECL.

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