Acting Comptroller of the Currency Michael Hsu says new standards for projecting credit losses will benefit banks and other financial institutions amid current economic uncertainty.
In a speech delivered earlier this week during a virtual conference hosted by the Risk Management Association, Hsu championed the new current expected credit loss, or CECL, standards that are poised to go into effect next year, saying the requirements provide flexibility to lenders along with conformity to existing risk management practices.
"We've heard fairly consistently from institutions that have implemented CECL that it better aligns with their credit risk management practices and has brought together multiple disciplines in the organization such as credit risk, accounting, modeling, and treasury that may previously have operated more independently," he said. "We've also observed that the quality and transparency of the discussion around credit loss estimates has improved under CECL."
Still, Hsu said implementing the new standards alone is not enough for lenders looking to gird themselves against economic uncertainty and potential instability.
Hsu urged banks to monitor how financial positions and behaviors change in the face of persistently high inflation and rising interest rates. He also said it was important for lenders to focus on concentrated risks and vulnerable borrowers in their portfolios, suggesting stress testing and sensitivity analysis as tools that should be used.
"Maintaining safe and sound credit risk management practices through this period of economic uncertainty is critical," he said. "Now is not the time to be complacent."
Originally issued by the Financial Accounting Standards Board in 2016, CECL was designed to be a common standard for how banks should position themselves to provide allowances for delinquent loans and, ultimately, absorb losses. The standards were intended to be a simplified version of the impairment calculation model in the Securities and Exchange Commission's Generally Accepted Accounting Principles.
CECL was finalized by the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp. and Federal Reserve Board of Governors in 2020. Large banks were required to adopt the standard by the end of that year, while community banks and other smaller institutions were
Hsu acknowledged that the added complexity of the current economic environment will make it more difficult for banks implementing CECL for the first time, but he said he was confident they would be up to the task, putting to rest any hope for a
"Similar to institutions that adopted CECL in 2020 at the height of the COVID-19 pandemic, these institutions will adopt CECL during a period of significant uncertainty," he said. "Like the 2020 adopters, I am confident that those adopting CECL next year will successfully implement the standard."
Overall, Hsu said, credit conditions in the banking sector appear to be "unexpectedly strong," with no noticeable signs of deterioration. Still, he noted, there are significant risk factors that need to be tracked closely, including wage growth that is lagging inflation, continued supply chain constraints and geopolitical uncertainty. Changes in workforce and consumer behavior stemming from the pandemic were of particular concern.
"Longer-term effects of the pandemic such as the shift in preferences toward online shopping, food delivery, and remote work are causing stress on the real estate market for shopping malls, restaurant spaces, and office buildings," Hsu said. "All of these factors can have a cascading effect that erodes business profit margins, debt service capacity, and collateral valuations, which may adversely affect credit risk levels at institutions."
Given these uncertainties, Hsu said, regulators will not expect perfect adherence to the CECL standards on day one. Instead, he said, they will be looking for a "good faith effort," adding that expectations will be scaled to the size of each bank.
"Small institutions don't need big models or overly complex methodologies," he said.
In his remarks at the RMA event, Hsu also addressed the importance of hiring diverse candidates, not only at the board level for banks and other financial institutions, but also within the employee ranks. He noted that a sufficiently diverse workforce could be a boon to risk management.
"I firmly believe that if we are serious about preparing our organizations to effectively manage risks, our workforces need to be up to the task of adapting to change and calling out institutional blind spots," he said. "This means creating cultures that foster a true sense of belonging for everyone.
"Unless people with diverse experiences and points of view feel empowered to speak up about the risks they see and to share their ideas for managing those risks, we will be stuck in an old school mindset, always fighting last year's war and overconfident in our risk management capabilities."
Hsu noted that he has faced the challenge of cultivating diversity firsthand in overseeing the OCC's 3,500-person staff. He encouraged financial institutions to incorporate diversity, equity and inclusion plans into their 2023-27 strategic plans and establish not only goals but also mechanisms for measuring them.
"In short, improving diversity and inclusion is a 'need to have' for us to achieve our mission of assuring safety and soundness, fair access to financial services and fair treatment of customers," he said. "It will help us ensure that we can adapt and respond to increasingly complex financial, compliance, operations, technology, cybersecurity and resiliency risks."
