Most businesses, large and small, depend on credit to operate. Whether this credit is used for daily operations, improvements, investments or other types of funded transactions, accessing credit to meet these obligations is often crucial. The process of obtaining credit might soon change as financial institutions begin implementing the new current expected credit loss (CECL) standard. Read on to find out more about the CECL and what it might mean for your business.
What is CECL?
The CECL is the new standard issued by the Financial Accounting Standards Board (FASB) that measures expected credit losses in regard to accounting practices by financial institutions.
Published in 2016 as a replacement for FAS-5 and FAS-114 and set to be implemented in December 2019, CECL will calculate the expected credit loss throughout the life of the loan. That contrasts with the previous incurred-loss method, which only measured credit losses after a probable threshold of loss. This change is in direct response to the financial crisis of 2008, and it’s meant to better reflect the actual financial condition of financial institutions.
Financial institutions can look at cumulative loss rate, migration analysis, remaining life, and the probability of default methodologies to estimate their CECL allowances for credit losses. The probability of default looks at different asset types to determine categories that loans qualify for. These assets are typically grouped as short-term (life under a year) or long-lived (life of at least one year) assets. This can affect the availability of small business credit lines at certain financial institutions.
The actual impact of CECL will not be known fully until some time has passed after its implementation. However, banks and other financial institutions currently are making changes in anticipation of its rollout. Some of the products that are expected to be affected include long-term loans because of the new life-of-the-loan expected credit losses that will be calculated. Lenders may now favor short-term loans, and they might increase their interest rate spread on longer-term loans.
Business owners are feeling concerned about how these new credit loss calculations could impact their businesses now and in the future. Acquiring credit might become more complicated, and banks might offer different types of loans as compared to previous loans. Now could be a good time to look into alternative lenders. In any case, gaining an understanding of the new CECL will be helpful for these businesses as they navigate new financial waters.
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