Credit risk
What is current expected credit loss (CECL)?
Current expected credit loss (CECL) is the US accounting standard requiring lenders to reserve for lifetime expected credit losses on financial assets at origination.
CECL is the credit loss methodology in FASB Accounting Standards Codification Topic 326, introduced by ASU 2016-13. It replaced the incurred loss model, which recognized losses only when they were probable. Under CECL, an institution estimates expected credit losses over the full contractual life of loans and other financial assets measured at amortized cost, and records that estimate when the asset is originated or acquired.
The estimate must consider historical loss experience, current conditions, and reasonable and supportable forecasts, with a reversion to historical information for periods beyond the forecast. FASB does not prescribe a method. Common approaches include loss rate, vintage, discounted cash flow, probability of default and loss given default models, and the weighted average remaining maturity method. CECL also applies to off-balance-sheet credit exposures, such as unfunded commitments that are not unconditionally cancellable.
CECL relies heavily on judgment, particularly in segmenting portfolios, selecting forecasts and applying qualitative adjustments. Thin historical data, inconsistent prepayment assumptions and poorly documented qualitative factors are frequent audit and examination findings. Because reserves are recorded up front, rapid loan growth can increase provision expense even when credit quality is stable.
